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Maria Bruno: Hi. I’m Maria Bruno, head of U.S. Wealth Planning Research here at Vanguard.
Joel Dickson: And I’m Joel Dickson, global Head of Advice Methodology at Vanguard. Welcome to our podcast series, The Planner and the Geek, in which we’ll discuss topics that are important to individual investors.
Maria Bruno: And we’ll have some fun along the way.
Maria Bruno: Joel, welcome.
Joel Dickson: Hi, Maria.
Maria Bruno: Good to be back in the studio with you today. I want to welcome our listeners to our latest episode of The Planner and the Geek. Today we’re going to talk about a topic that is near and dear, I think, to all of our hearts, and that’s planning for health care costs.
Joel Dickson: Yes.
Maria Bruno: It’s a topic that we all must deal with. Personally, it’s one of the biggest questions that I get from folks who are starting to think about retirement. So it resonates, I think, with all of us, but particularly as we near retirement and then throughout retirement making those choices around how to pay for health care costs and what health care costs look like. It’s a big topic. In fact, a recent survey—this is a 2016 PwC Financial Wellness Survey. We’ll start off with some interesting statistics. 38% of the boomers who were interviewed listed health care as a top fear about retirement. And, in fact, only 5% of these individuals cited that managing their investments was a concern. So you can see there’s an overwhelming concern around how to manage health care costs. I think it’ll make for an interesting conversation.
Joel Dickson: Maria, I concur, because it is certainly something that we hear a lot from clients and investors—throughout the course of their life stages, the different health care considerations. So what we really want to talk about in the podcast today are three things: health care costs and the budgeting situation in the working years, preretirement; when you start thinking about retirement, how you start thinking about projecting those health care costs and trying to decide whether you are going to be able to meet your retirement sufficiency goals; and, finally, when you’re in retirement, thinking about the trade-offs between annual health care expenses, those ongoing each and every year costs, the potential issue of long-term care, and thinking about how you might plan for those. Seem like a good group of topics?
Maria Bruno: More than enough to talk about today.
Joel Dickson: Yes.
Maria Bruno: I don’t know how we’re going to do it.
Joel Dickson: Yes, somehow, we’ll get it all in, right? I do think most people are generally aware that health care costs have been rising faster than inflation, because you can certainly see it on your own bills and how much your premiums have increased, and your deductibles and so forth. One of the stats that I have—this is from a study done by the Commonwealth Fund—in 2017, 56% of Americans under the age of 65, or in number terms, 152 million people, had insurance that was through an employer. It may not be their own employer, it may be a spouse or another relative, but 56% had insurance through an employer.
Surprisingly, because oftentimes we hear so much talk about the Affordable Care Act—which some people call Obamacare—and the whole political debate about that, only 9% of folks, according to this study, under the age of 65 actually purchased on the individual market, and that would include the exchanges. The main way that people access health care is through an employer or an employer-sponsored plan today. And on average—and this is important for this discussion, especially as you transition to retirement—employers subsidize about 75% of the premium in the under 65 employer-based health system in the U.S. today.
Maria Bruno: Joel, let’s talk about HSAs and what makes them interesting. So, triple tax advantages with a health savings account, which makes it even better—
Joel Dickson: That sounds good to me. What does that mean, Maria?
Maria Bruno: It’s even better than a Roth or a 529.
Joel Dickson: No. Better?
Maria Bruno: Better.
Joel Dickson: Better! No such thing as better than a Roth. Come on!
Maria Bruno: Oh, you know because you invest in one. So, the contributions are tax-deductible, the account grows tax-deferred, and then assuming withdrawals are used for qualified medical expenses, they’re tax-free.
Joel Dickson: So no taxes ever if you meet the right conditions under the current law. Have to put in all those disclaimers for our legal friends.
Maria Bruno: Yes, thank you. I pause—with the proper legal caveats, yes. And what’s interesting is you don’t necessarily have to incur those medical expenses in a year. So it’s not one of these use it or lose it; the account can grow and continue.
Joel Dickson: What? Wait. As you would say, Maria, tell me more.
Maria Bruno: So with the HSA, if you incur medical expenses throughout the year, you can choose to pay out of pocket for those medical expenses and not touch the health savings account. Now granted, this is probably a benefit that not everyone may be able to afford, but it does—
Joel Dickson: For high savers, it gives that option.
Maria Bruno: Yes, for high-income earners or high savers. You can think about a health savings account a little bit differently than you would a traditional health account or a health insurance plan.
Joel Dickson: But like you said, it sounds like the combination of a traditional IRA and a Roth IRA in that you get the tax deduction and you get the tax-free withdrawals, assuming that the right conditions are met.
Maria Bruno: Right. And there are limits. For 2019, an individual or an employer combined can contribute up to $3,500, a family up to $7,000. So that’s how much you can contribute this year to an HSA. If you’re over 55—55 or over I should say—it’s an extra $1,000. So there’s catch-ups, but they’re different than the IRAs and 401(k)s.
Joel Dickson: Right. At age 50 there.
Maria Bruno: Right, so you can’t do that quite yet.
Joel Dickson: No, not yet. Neither can you.
Maria Bruno: Something for you to look forward to, Joel.
Joel Dickson: Oh, yes. I will. So it does sound like you could use that as another form of long-term savings and the benefit being that, as you had mentioned just previously, you don’t have to line up your health care costs or health care payments with the amount that you take out from the health savings account. So I could incur a cost today and then withdraw the money from an HSA 20 years from now for that cost if I wanted to, correct?
Maria Bruno: Correct, yes. Sometimes we’ll call it shoe boxing receipts, although you don’t have to keep a shoebox. You can do it digitally with apps today. But you can actually go back and claim those receipts later and take the withdrawals, thus the qualified withdrawal criteria being met. There’s really two ways you can use an HSA. One would be as a transactional account. The other would be as an investment account as you had just mentioned. With the transactional account, you still get the benefit of the tax deduction with the contributions, but perhaps you’re using the money to pay for medical expenses versus considering it an investment account and not touching the money and let it grow tax-free.
Joel Dickson: So it’s really another way to get a tax deduction, at least on the deductibles that you might be paying out of pocket, which otherwise would be done with after-tax money. Oftentimes the premiums are with pre-tax money from an employer-sponsored plan. But if I had to pay that $3,000 deductible—if I had $3,000 that I contributed to a health savings account—even if it’s transactional, I would get a tax break on the $3,000 and then pay those dollars.
Maria Bruno: Right.
Joel Dickson: Yes, so that’s a big benefit.
Maria Bruno: Now, what to think about if you’re picking an HSA? Certainly you want to look at the cost of the plan. If they offer a high-deductible plan with an HSA, you can choose through your employer. You have a portability option, so if your plan doesn’t have good options in terms of either costs or investment choices, there’s a portability feature that you can roll the money out of the plan as well too. So some unique features there to consider.
Joel Dickson: Or use it as a retirement savings vehicle as you said, right? If you’re able to save extra—
Maria Bruno: Oh, absolutely!
Joel Dickson: We’ve even started talking about hierarchy around when you would save in an HSA versus other vehicles.
Maria Bruno: Yes, when you think about the savings hierarchy, certainly. We talk about this a lot—save in a 401(k) up to the company match if you have that. That should be first and foremost. And then, whether or not you’re savings constrained, think about an HSA. Certainly if you’re not savings constrained, that makes the choice a lot easier. You can go into the HSA, reap the tax benefits, and consider it as a retirement account. But if you are savings constrained, think about it. Even if you use it as a transactional account, there may be some tax benefits there that may be material.
Joel Dickson: Yes, we started talking about different nuances. For example, if you’re going to make a $3,000 contribution to a kid’s 529 plan, would it make sense to, if you’re going to incur $3,000 of medical expenses—even though you’re using it as a transactional account—put it into the HSA. Get the tax deduction. That money comes out. Now you go in the 529 plan, you pay the health care cost then, if you will, out of your own pocket. At the end of the day, you still have some after-tax amount that you’re paying for either health care or the 529 plan, but it may be a way to capture some benefits there.
Maria Bruno: Yes. And before we leave HSAs, the only other thing that I would add would be there are caps that you would spend every year. So even though there may be higher out of pocket, potentially there are still caps in terms of the maximum amount you would pay out of pocket.
Joel Dickson: Well that depends on the plan, right?
Maria Bruno: Correct. Yes.
Joel Dickson: Yes.
Maria Bruno: Anyway, I think we do need to talk about HSAs in this context, because they do offer an appealing option—and a versatile account, I might add.
Joel Dickson: As you said, in employer-sponsored plans, it’s probably underutilized by participants today given what we’ve seen—even as a transactional account, much less as a potential investment account.
Maria Bruno: Correct.
Joel Dickson: So when we think then about how we project these costs through or thinking about retirement, you and I are both getting to the point where we’re at least starting to understand what our costs might be in retirement or how we might start thinking about that. And how can we get started with this health care piece? You look at studies of consumer expenditures and health care is the largest—or close to the largest—expense for many people in retirement in terms of broad categories. So how do we start thinking about projecting that going forward?
Maria Bruno: One way to think about it would be this transition from working years into your retirement years. We talked about employer plans with generous employer subsidies. So when we think about these other costs—for instance, when you think about food or housing or shelter, things like that—as you’re planning for retirement, those necessarily aren’t going to change the day after you retire. Health care may because if you have an employer subsidy, that subsidy may go away, and that may mean that you may be responsible for greater out of pocket. So when you think about replacing that income, you might have to pay more when you retire to make up for that generous employer subsidy.
Joel Dickson: That’s interesting, because those that have benefited most—let’s say they work for someone that actually subsidizes quite a lot of their health care expenditures—probably need to project more in terms of what we often call the replacement ratio, in terms of their current income, in terms of retirement expenses, because of that subsidy going away. If I think about the number that I gave before, how on average about 75% of the premium is subsidized, if a family premium—just to throw some numbers out there—was $10,000 a year and the employee is paying $2,500 during their working years—now things will change with Medicare, but all else equal—that would be an extra $7,500 a year of expenses that now come into play in the retirement years. That’s a lot.
Maria Bruno: Well, it is. And we actually think it’s better to think about it in terms of annual cost framing as opposed to a big number at retirement. There’s a lot of what we call big, scary numbers out there—numbers around what the health care costs in retirement could look like. Some quotes are a couple hundred thousand dollars. Well, that’s a legitimate concern. We don’t think about food and housing in those types of big, scary numbers either. Why would we think about health care in that light?
Joel Dickson: Yes, I’m going to spend $5,000 a year on food or whatever it might be, but we don’t aggregate it up and say, “You better save $200,000 for food for your retirement.”
Maria Bruno: Yes, it’s a useless number from a planning standpoint. It’s better to think about it in terms of what costs potentially look like, what you are responsible for in terms of out of pocket, and then do the planning from there. We talked about health care costs increasing dramatically with inflation. That’s true and that’s a concern, but what we also see is what we call the substitution effect—as you age through retirement, health care costs as a percentage of your overall costs may increase but other expenses go down. So that’s where the substitution effect might come into play—it may balance out or net out over the years, but health care costs may be a greater percentage of your overall spending.
Joel Dickson: I definitely see this in real time with my parents—for example, my dad and my stepmom, who are now in their late 70s to mid-80s. In the early phases of their retirement 10–15 years ago, their expenses looked very different as a basket, whereas right now it’s largely housing and health care. There are not a lot of other costs they have besides those. And 10–15 years ago, there were other things in there—like travel, other recreation, and dining out—that just aren’t there. So that substitution effect—yes, health care costs have risen, but a lot of their other expenses have not as they’ve become less mobile and less able to do those other things.
Maria Bruno: And when you think about health care costs, break it down in terms of annual health care costs as premiums, out of pocket. Then the other one, which arguably could be the big, scary number, is long-term care. So when we think about health care, it’s best to decouple those two and look at health care costs in retirement as one aspect and then long-term care, and understand the trade-offs there and the considerations as you’re planning throughout retirement.
Joel Dickson: In the research that Vanguard has done on this topic, Maria—and you mentioned it a little bit earlier in a different context—looking at those health care costs and the long-term care costs, there is some predictive ability to have a sense of what those costs are. So things such as what your health status is at the time of retirement—is it good, is it moderate, is it not particularly healthy—have a big determinant on what the annual health care costs might be. So if you do have chronic conditions like smoking, emphysema, heart disease and so forth, you can get a sense of where things may be. It’s interesting, though, because you mentioned long-term care. Long-term care will often come in for people that may actually have been quite healthy at the time of retirement. So you’ve got this weird dynamic that goes in where you may have a lot of costs for a short period of time, relatively on average, if you’re unhealthy at retirement, but you might have a greater risk for long-term care if you’re very healthy at retirement. It’s a weird planning process.
Maria Bruno: Our research showed that about half of individuals will not incur any type of long-term care costs, about a fourth of individuals will incur costs that may be below $100,000, and about 15% will incur costs over $250,000. So what you can see there is that not everybody will incur long-term care shocks, but those that do, they could be significant.
Joel Dickson: Yes. And as you said, most won’t incur long-term care costs, yet I think everyone fears it.
Maria Bruno: Well, I think everybody has a story too.
Joel Dickson: It’s true.
Maria Bruno: It is a very personal consideration, and I think individuals can look to either family or friends and the stories that go along with that. When we talk about long-term care, the one thing we really haven’t discussed is unpaid care options. And there’s a lot of individuals who get long-term care through family. So really what we’re zeroing in on here are paid long-term care expenses.
Joel Dickson: Yes, which by and large, tend to be—at least in a couple or in a two-person household situation—the second to die more so than the first to die. The first to die tends to have more unpaid care. That’s not uniform, but on average relative to the second to die.
Maria Bruno: Statistically, it’s women. Women’s life expectancy is greater than their male counterparts, so what we tend to see is that women have a higher occurrence of long-term care needs than men.
Joel Dickson: Yes, absolutely. One of the things that we didn’t touch on was the planning process in retirement in terms of Medicare and what kind of costs and thinking and understanding needs to be done along those lines. But I think we might be able to get to that with a couple of client questions that we have received on health care topics. For example, I think this is a good lead-in to what it means after 65 and gets to some of these Medicare questions. Jacqueline asks, “What health care options would you recommend for retirees who are younger than 65 and not yet eligible for Medicare?”
Maria Bruno: That’s a very common question among pre-retirees, isn’t it? So I would think about this in two ways. One would be the options, but then also, how much will I pay for this? So we talked about the employer subsidies and the loss of that. For somebody who’s retiring pre-Medicare, they’re going to think about how they’re going to bridge those health care costs and how much they’re going to pay for that.
So one would be if you have an employer that allows you to have coverage that bridges to Medicare, certainly that’s one option, or maybe COBRA—that could get you a limited period of coverage. And the other option would be to go into the open market and look for policies.
Joel Dickson: The health care exchanges.
Maria Bruno: Yes. There you’ve got the choice of Gold, Silver, or Bronze plans. I think we tend to see Silver plans being more widely adopted. So that is one way to bridge that gap between your working years and Medicare.
Joel Dickson: And then when you do get to the actual retirement piece—I think this is well encapsulated by a question that William asked, “What do you recommend as to budgeting for health care?” So a little bit more specific on some of the things we’ve been talking about. And when he’s talking about budgeting, he’s thinking of both insurance costs and out-of-pocket expenses.
Maria Bruno: And you have to think about both of those, right? When you think about insurance, you may either pay for it in terms of higher premiums, potentially lower out of pocket, versus a lower premium and a higher out of pocket. So that’s a personal decision in terms of how are you comfortable paying for that health care.
Joel Dickson: Well, and that’s where things such as your current health status and what combination of Medicare plan or supplemental plan or Advantage plan comes into play. And there it can differ a lot by geography, health status, as I mentioned, and your income amount in terms of how much of a subsidy you might get or not get. All of those things come into play in that. Which is why, in many ways, we partnered with Mercer and wrote this research on health care costs, because trying to look at that in the aggregate is extraordinarily important for being able to budget in a way like William is asking, and get a good sense of these costs. And while it may seem complicated and there are a lot of moving parts, you can get pretty good, in-the-ballpark numbers of what an annual out-of-pocket cost would be in retirement.
Maria Bruno: Joel, I think you’re on point. When you think about the Medicare choice—and there are choices with Medicare, there’s not just one option—I think it does make sense to stop and think and look at the different plans to assess the trade-off between the premiums and the potential out of pocket.
You had mentioned the different health risk factors that go into it as well. We’ve done some work in the research paper. And if you look at a medium-risk individual with a Supplemental F—we pick F because that is one of the plans with the highest coverage—the annual cost is $5,200. High risk is about $6,500. So that gives you a ballpark sense of what you could be looking at in terms of total out of pocket with a Medicare Supplemental Plan F. The other thing I will add is for individuals who are then considering Medicare with a supplemental—those are plans that cover the 20% that Medicare doesn’t cover—that’s usually appearing when you think about insurance, but then also prescription plans and that’s the Part D.
Joel Dickson: Part D, yes.
Maria Bruno: And, again, these are—not to get into Medicare. We could spend an hour talking about that.
Joel Dickson: Maybe we will at some point.
Maria Bruno: The Medicare choice is between typically with an Advantage plan, which is kind of all-in, versus traditional Medicare, plus an optional supplemental, plus a Part D plan. So there’s some decision-making there. It really makes sense to stop and understand the plan choices and the costs that you’re facing either with the annual premiums or out of pocket.
Joel Dickson: And, as you say, the number of choices, the number of permutations you could have in terms of satisfying those health care pieces in retirement is large. That’s why we’re starting to see more and more advice providers moving into these areas as part of financial life management or financial life advice, where things such as—and we’ve talked about it in other podcasts—Social Security optimization, or when to claim Social Security and how, or in this case, Medicare choice along with all of the other optional coverages and how to bundle that together for personalization or customizing that to the situation at hand. So, in many ways, that is how a lot of the advice frontier is moving in the financial planning space, correct?
Maria Bruno: Absolutely. And it’s not once and done either. You want to revisit—certainly, once you pick your Medicare plan, but think about the supplemental and the Part D as well.
Joel Dickson: Yes.
Maria Bruno: Part D you should check every year because there’s not only the cost, but there’s formulary drugs and the formulary list changes every year. So you really want to be proactive and understand what your plan covers and make sure on an annual basis that it’s appropriate for your needs at that life stage.
Joel Dickson: There have been some academic studies done—I want to say that the one I’m thinking about was in the book Nudge that looked at medical plan choice broadly. And it was something like over 40%—I don’t remember the exact statistic off the top of my head—but over 40% of people had chosen a wrong plan for their situation, because they went to a default or what was presented or what their friends did. And this can make, with the numbers that we’re talking about, a significant difference in adapting the plan choice for your situation in terms of the budgeting questions that William asked.
Maria Bruno: And I will say the Medicare website is quite good. So medicare.gov is a good source of information for individuals that want to dig a little bit deeper.
Joel Dickson: If you have about 20 hours on your hands.
Maria Bruno: And the Geek doesn’t have 20 hours?
Joel Dickson: I’ll go geek out about that. When it comes time for me to choose my Medicare plan, I will be all over that. However, I don’t think I’m the normal person when it comes to that.
Maria Bruno: Well, I’ve spent some time on that website. So for our listeners, the Planner has spent some time on the website and thinks it’s pretty good.
Joel Dickson: Good. So there’s one other question that we get from a client standpoint that certainly plays into this topic. This is from David, “How do you balance retirement plan withdrawals with preparing for future health care expenses?”
Maria Bruno: This is an interesting question. It is a balancing act for many individuals. A couple things that I would think about there—we talk about strategically spending from retirement accounts from a tax situation. And I think it’s impactful here as well. The one thing I would think through here is try to keep that income down for two reasons. One, if you’re on the public marketplace for insurance coverage, there are subsidies that exist, but those subsidies are based upon income thresholds. So look at the income just to see how to—if you are benefiting from subsidies, if you’re on the open market in terms of purchasing your insurance—think about the impact there. The other thing I would say is once you’re in retirement, Medicare Part B premiums are based upon income levels as well. So, as you know, RMDs from traditional deferred accounts are part of your taxable income. And that figure then not only determines how much you have to pay in income taxes, but it also has hidden implications, or somewhat hidden implications—things like Medicare Part B premiums.
Joel Dickson: Yes, this is back to the whole thing that you and I have talked about for a long time about diversifying the different sources of taxable income that you might have in the future, because then you can—if you will, lightly quoted—“optimize” around some of those situations. So things like Roth IRA contributions and then withdrawals that strategically may not add to taxable income and, therefore, may not have that impact on the Medicare Part B premiums or on Social Security taxation and so forth. At the end of the day, David’s really asking the question, shouldn’t I think about my total portfolio in aggregate and my total situation—as opposed to thinking of my retirement plan, my health care expenditure, my Social Security, my taxable account, whatever it might be? And that’s exactly right. There are so many different trade-offs and interactions—you need to think about it very holistically in order to reap the benefits. Good example is the health savings account that you talked about earlier—can I use the health savings account in a strategic way if I had that from years ago and now in retirement? This is mainly going to be for people in the future, but I could use that to think about, I have that health cost from 15 years ago—how about if I take the money for that right now? It doesn’t count towards my income currently, so it doesn’t affect my other premiums and so forth.
So, yes, it’s a very complicated situation. But at the end of the day, it’s about looking at it in total.
Maria Bruno: Absolutely. So, Joel, before we wrap up, I did want to go back. We talked about some of the research that Vanguard has done. The research can be found on vanguard.com; it’s called Planning for Health Care Costs in Retirement. I think that’s a good starting point for individuals that might want to dig deeper on some of the topics that we talked about today.
Joel Dickson: I agree. It’s actually nice touting our own book as it were. It really is a nice paper and, again, working with Mercer experts on the health employer benefit side, bringing that planning perspective into it, and being able to give a better sense of the annual health care costs and the issues with long-term care as well.
Maria Bruno: Yes, and I think the other thing in the resource corner would be the medicare.gov website—I’ll make the final plug for that. And for individuals who want to personalize this more—work with a professional, an advisor. A financial planner can help personalize this a little bit more. Give us a call at Vanguard. We have advisors who can also do some of the planning with individuals as well around health care costs.
Joel Dickson: Yes, that’s exactly right. And to sum this up, it’s important to think about the fact that retirement isn’t just about how much money you have. It’s also about spending, what’s contributing to it, what the quality of life is, what your choices are. So it’s health and wealth, and they’re linked in many ways as we’ve talked about today. But it is important to think about the costs of health care in retirement on an annual basis, as opposed to a lump sum covering the rest of one’s life—as you said, think about it in the same way that we think about any other ongoing expense like food and clothing and housing.
So we really need to educate ourselves and assess our own situation—do our own planning—knowing that while the future is hard to predict, there are some things that we can at least plan for a little bit more directly.
Maria Bruno: Joel, thank you very much. I think we covered a lot of good ground today. I hope our listeners found it useful as far as the resources that we talked about.
To continue the retirement and retirement spending conversation, our next podcast we’re going to be covering Social Security and navigating Social Security and claiming choices.
Joel Dickson: Yes. That’s probably no less complicated than the health care discussion that we had today.
Maria Bruno: Yes. So our challenge will be to make Social Security interesting, and I think I’m up for the challenge. How about you?
Joel Dickson: Go for it.
Maria Bruno: All right, thank you.
Maria Bruno: We hope you enjoyed this episode of The Planner and the Geek. Just a reminder that you can find more episodes of The Planner and the Geek on iTunes and on vanguard.com.
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