Medical Costs Spell Trouble for Boomers

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Here’s a cheerful title: “Will Health Care Costs Bankrupt Aging Boomers?”

Of course, it’s a fear shared by many baby boomers, but the Urban Institute has put some numbers on the problem with a new study examining premiums, deductibles, co-pays and “holes in benefit packages” that could inflate boomers’ out-of-pocket expenses despite Medicare coverage.

The report exposes one of the chief problems of preparing for retirement: incorporating long-term inflation averages could leave you short, as your personal inflation rate could exceed the average by a wide margin. The Consumer Price Index considers prices of thousands of good and services, but your retirement expenses may be heavily weighted toward medical outlays that go up faster.

The study uses the Medicare system’s own cost projections to conclude that between 2010 and 2040 annual out-of-pocket costs for people 65 and older will mushroom from $2,600 to $6,200, measured in inflation-adjusted 2008 dollars.

Growth in older Americans’ household income will be nowhere near as great, rising from $26,800 in 2010 to $34,600 in 2040. Those gains rely on a somewhat optimistic assumption that Social Security benefits will rise.

With costs rising faster than incomes, the percentage of income spent on health care will nearly double over 30 years, from 10% to 19%. If employers eliminate all health benefits for retirees by 2040, more than half of all older Americans will be spending more than a fifth of their income on health care, a level experts consider burdensome.

Obviously, conditions will be even worse if medical costs rise faster than in the past, as many experts expect.

So, what’s to be done about it? Barring a dramatic cost-controlling change in health care, it seems only prudent to save more and modify retirement plans.

It’s always been difficult to estimate one’s cost of living in a retirement that’s many years away. Typically, one starts with adjustments to current costs, subtracting figures for commuting, mortgage payments, college savings and other expenses that may end by then. Health care costs, travel and other expenses are then added.

Many experts have long assumed one’s cost of living in retirement will be about 70% of the pre-retirement cost, but that could be overly optimistic if the Urban Institute’s projections are right.

If you’d figured you could retire on $75,000 a year, rising health costs could push the figure to $80,000. Since your expense could be higher than average, it might be better to assume $85,000.

What’s it take to increase retirement income by $10,000 a year? Using a standard assumption that you can withdraw 4% of a nest egg a year, you’d need additional assets of $250,000. If you’re a baby boomer you’re already in your 50s or 60s. Saving another $250,000 in five or 10 years would be quite a task.

That leaves two options: cutting other retirement expenses or postponing retirement. For most people, the most practical strategy involves both moves plus increased saving, which means cutting current expenses.

Use the Retirement Income Planner and Retirement Planner to experiment with the numbers.

Hopefully, things turn out better than the Urban Institute expects. But they could turn out worse. It’s pretty hard to find an expert who thinks health care costs will go down.

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