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Planning for retirement

Planning for health care in retirement

Planning for retirement health care is probably easier than you expect. Start by considering your personal situation.
14 minute read
When it comes to retirement planning, health care is a top concern for most people. Unpredictable factors like rising health care costs and potential illnesses   make planning for future health care expenses especially tricky. But breaking it down to guide the process can help you feel more comfortable about your situation once you retire. This article outlines 3 major drivers of health care expenses and 4 steps you can take to plan effectively.

3 things to consider when saving for health care in retirement

As you age, there may be times when you experience higher or harder-to-predict health care expenses. The following factors are important to consider as you prepare for potential fluctuations.

1. Inflation

Medical expenses typically increase faster than other costs because of a shift to more expensive services and the emergence of new treatments and prescription drugs. For example, premiums for Medicare Parts A and B increased by 6% in 2024, but the Social Security cost-of-living increase for that year was only 3.2%.1

Higher costs can cause some retirees to delay medical care and downgrade their health insurance in retirement to save money. This can create a cycle where retirees use lower premiums to save money but end up paying more when they require medical attention. Planning ahead for increasing premiums can help prevent financial strain.  

Advancements in medical treatments can also contribute to longer lifespans, which should be considered when planning. This is also important to consider when preparing for the possibility of needing long-term care. More than half of retirees will need long-term care, which can get pricey because Medicare doesn't cover it.2 It's important to plan for it in case you need it.

2. Health issues

As you age, your risk of injury or health incidents increases, so it's important to prepare for the unexpected. The sooner you plan, the more time you'll have on your side to save and help mitigate some of these expenses.

One of the biggest factors in determining your potential retirement health care costs is your health status and risk. If you're a smoker, visit the doctor frequently, or have 2 or more chronic conditions like diabetes or heart disease, you'll likely incur higher costs than those who are free of chronic conditions.

Remember that your expected health care costs will be different from anyone else's. You'll need to consider the factors above to help you determine how much you'll need. Another thing to keep in mind is that while your health care costs are likely to increase later in life, they'll likely be offset by reduced spending in other categories.

3. The retirement gap

For most of us, an employer has been subsidizing our insurance costs all our lives. If that applies to you, then you'll likely need to cover those costs if you decide to retire before age 65. That's when you'll qualify for Medicare, the government-sponsored health insurance program for retirees. The average retirement age in the United States is 62, which leaves a 3-year gap before Medicare eligibility. If you plan on retiring before age 65, you'll need to pay for medical coverage until you're eligible for Medicare. And while many people believe that Medicare will cover all their medical expenses, that's not the case. This is covered in more detail below. 

In some cases, your employer may offer continuing insurance coverage as part of your retirement package. If they don't, another possibility is to remain on their plan through the Consolidated Omnibus Budget Reconciliation Act (COBRA), which allows workers and their families to continue health benefits under a former employer's plan. COBRA usually only lasts for 18 months, but it could help bridge the gap if you retire within 18 months of turning 65. Doing this will allow you to continue the same coverage you had while employed, but since your employer won't be subsidizing the costs, it can be expensive. 

If you're married, you can stay on your partner's plan if they're still working and have access to employer-sponsored coverage. If this option is available to you, it'll likely be the cheapest way to remain insured.

What factors affect health care costs for retirees

Since health is personal, it's going to look different for everyone. Understand what the factors are and how they might affect you.

Learn more about the factors that affect health care costs

 

4 steps to financially prepare for your retirement health care needs

There are things you can do today to help prepare for your retirement health care needs. Look at your lifestyle and family history to help estimate what your costs might look like. You can get a personalized health care estimate from an advisor, open a health savings account (HSA) to start saving for medical expenses, review—but don't rely on—replacement ratios, and weigh your Medicare options.

Learn more about planning for health care in retirement (PDF)

1. Get a personalized health care estimate

Incorporating health care costs into your financial plan helps ensure you're well positioned for retirement, even if you should encounter a medical emergency. As part of Vanguard Digital Advisor® and Vanguard Personal Advisor®, you have access to our health care tool, which can provide a personalized estimate for your health care and long-term costs to help you more accurately account for those expenses in retirement. Once you have that estimate, you can work on your own or with an advisor to incorporate it into your savings strategy.

Get more with advice from Vanguard
 

2. Open an HSA

If you participate in a high deductible health plan (HDHP), you may qualify for an HSA. An HSA allows you to set aside and invest pre-tax money and use it to pay for qualified medical expenses. Note that you can't contribute to an HSA if you have health care coverage that doesn't qualify as an HDHP. Once you begin Medicare coverage, you won't be eligible to contribute to an HSA, so take advantage while you can. The sooner you start saving, the more you could benefit.

Among the biggest advantages of HSAs is their triple tax benefits:3

  • Contributions can reduce your current taxable income.
  • The money grows tax-free within the account.
  • Qualified withdrawals—meaning money used for most medical expenses—are tax-free.

Before you reach age 65, you can use the money in your HSA for expenses like copays, deductibles, and medications. You usually can't use this money to pay for insurance premiums, apart from COBRA, Medicare, and long-term care insurance (up to the deductible amount). Once you turn 65, you can use the money in your HSA for anything you want. But keep in mind that if you decide to use it for things other than qualified medical expenses, it'll be considered taxable income.
 

3. Review replacement ratios

The further you are from retirement, the more difficult it is to envision what your spending needs will be. However, projected spending is critical for determining the savings rate you'll need to maintain your standard of living. Financial planners often use replacement ratios—the percentage of pre-retirement income that someone will need to maintain their current lifestyle—to provide estimates of retirement spending needs. They're frequently used to estimate required savings rates. However, many traditional default replacement ratios don't account for increases in health care costs. It's especially important to factor this in if your employer offers generous health insurance benefits.

Typical replacement ratios are between 70%–85%, but all the variables that account for health care costs suggest that accepting a ratio in that range might not be sufficient for those with pre-existing health conditions, a family history of health issues, or those who end up requiring long-term care. So, while you review the replacement issues, don't solely rely on them since your situation may require more.

Learn more about planning for long-term care
 

4. Weigh your Medicare options

Once you get closer to age 65, you'll want to take time to review your Medicare options. When you're eligible, remember to sign up during the designated enrollment period. There's a lot to know about Medicare Parts A, B, and D, Medicare Advantage plans, and Medigap plans. What are the different parts?

  • Part A covers hospital costs.
  • Part B is optional coverage for outpatient and doctor visits.
  • Part C, also known as Medicare Advantage, provides additional coverage by private insurance companies.
  • Part D is prescription drug coverage.
  • Medigap policies are supplemental policies offered by insurance companies that help cover out-of-pocket costs, such as co-pays and deductibles.

Learn more about Medicare

Preparing today will help you feel more confident tomorrow

While your health care costs are likely to increase later in life, keep in mind you may spend less on things like transportation, clothing, and housing. Remember that your expected health care costs will be different from anyone else's. Breaking down planning into steps while considering your personal situation can help ease the process and help you feel more confident about this very important part of retirement planning.


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1Source: Forbes, Inflation Can Be Bad for Your Health in Retirement, 2023. Note that the Social Security cost-of-living increase and Medicare premium costs are announced the prior year.

2Source: CNN, More than half of older Americans will need long-term term care. Many can't afford the rising cost, 2023.

3Nonqualified withdrawals from a health savings account may be subject to taxes and a 20% federal penalty tax.

 

All investing is subject to risk, including the possible loss of the money you invest.

Neither Vanguard nor its financial advisors provide tax and/or legal advice. This information is general and educational in nature and should not be considered tax and/or legal advice. Any tax-related information discussed herein is based on tax laws, regulations, judicial opinions, and other guidance that are complex and subject to change. Additional tax rules not discussed herein may also be applicable to your situation. Vanguard makes no warranties with regard to such information or the results obtained by its use, and disclaims any liability arising out of your use of, or any tax positions taken in reliance on, such information. We recommend you consult a tax and/or legal advisor about your individual situation. 

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