Illustration by Chris Gash

Faced with woes, “Gone with the Wind’s” Scarlett O’Hara optimistically vows: “I’ll think of it all tomorrow…. Tomorrow is another day.” Little Orphan Annie counts on tomorrow to dump the blues: “Tomorrow, tomorrow! I love ya, tomorrow!” And Fleetwood Mac’s hit implores: “Don’t stop thinking about tomorrow” (likewise Bill Clinton in his 1992 campaign).

Putting the focus on tomorrow means, of course, zeroing in on the future, largely unknown. For an increasing number of folks, tomorrow means retirement. How do your clients view tomorrow? What have you, as their financial advisor, done to help them deal with their future, perhaps 20 or 30 years long? How well are they prepared for the dollar demands of retirement?

This is important: The cost of health care is high and getting higher all the time. Do you factor into financial plans the estimated average $220,000 in out-of-pocket expenses—excluding dental and long-term care—that a couple, age 65, having retired in 2014, will need in order to cover whatever Medicare doesn’t throughout their retirement? Medicare pays only a little more than 50% of medical costs; retirees are obligated to foot the balance on their own.

The reality is that if FAs aren’t broaching the subject of saving for health care costs, it’s a good bet their retirement clients haven’t planned or budgeted for them. Either it’s never occurred to them, or they’ve simply pushed it out of their minds since the issue is essentially a downer with complex details.

“People keep their fingers crossed and hope they’ll make it by dealing with things as they come up,” says Joshua Kadish, a partner in RPG-Life Transition Specialists, financial planners in Riverwoods, Illinois.

But ad-libbing is walking a tightrope. Increasingly steep medical costs are a fact of life. These can include emergency expenses for surgeries required because of a critical illness or accident.

“Health care costs are like college costs because they go up twice as high as inflation. For the last decade, medical inflation and educational inflation have been about two times what regular inflation is,” says C. Richard Hearn, principal of Starcare, in Irvine, California. An LPL Financial branch manager, his practice consists primarily of clients with disabilities.

Hearn continues. “Health care costs go up 100% a decade, and we’re all living longer. So when you get into your eighth, ninth and even tenth decades, it gets darned expensive.”

Worried Wealthy

Compared to the general population, more high-net-worth retirees (60% vs. 41%) cite health care expenses as their top retirement financial worry, according to additional data released last December from Bank of America Merrill Lynch and Age Wave’s September 2014 study, “Health and Retirement: Planning for the Great Unknown.”

Further, the new analysis shows that affluent individuals are more likely to be proactive in caring for their health, such as exercising and sticking to a healthful diet. Plus: Wealthy people age 50 and over are almost three times more likely to try to estimate how much money they’ll need for health care and long-term care in retirement.

All of that presents a prime opportunity to discuss health cost planning with high-net-worth clients.

“Following healthful practices likely translates into how people handle their finances,” Kadish says. “If nothing else, they may be more open to taking the same approach with their [money] as they do with their health—understanding ailments and getting a prescription or workout regimen to improve the situation. We see that correlation with our clients.”

Kadish recommends bringing up health care expenses in the first meeting with every new client.

“You need to build these costs into their budget. We’re being ultra-conservative so that there’s some wiggle room just in case a catastrophic medical event occurs or there’s market downturn,” Kadish adds.

The good news for clients and advisors is the availability of a number of tools and solutions to help retirees set aside funds for health care expenses—or even reduce them. These allow FAs to create a financial blueprint for future medical care within the client’s overall retirement plan.

Admittedly, it takes finesse to start the oft-touchy health care conversation.

Besides, “the fallacy is that if you just explain to someone they need to [save] because the future is important, they’re going to change. But there are variant endemic differences in people—so there’s no one strategy for dealing with clients that’s going to work for everyone—and by [pre-retirement], people are pretty much hardwired for the way they think about the present versus the future,” says Lamar Pierce, associate professor at Olin Business School at Washington University, in St. Louis.

A study, “Healthy, Wealthy and Wise: Retirement Planning Predicts Heath Improvements,” that Pierce co-authored and released last summer shows how employees whose firms offer 401(k) plans think about tomorrow. The research found that people who contributed were more likely to correct indicators of poor health later revealed in company-sponsored medical exams.

“Existing retirement contribution patterns and future health improvements are highly correlated,” the researchers wrote, explaining that “retirement planning predicts employee health-improvement behavior.”

Diverse Structures

One route to saving enough to cover medical bills in later years is via a health savings account, introduced in 2005. The HSA typically is offered to employees who are enrolled in their companies’ high-deductible health plans.

Tax-advantaged, “the HSA is the fastest growing benefit structure that we see at Bank of America Merrill Lynch and in which advisors are taking an extremely strong interest to work with individual clients,” says Kevin Crain, BofA ML senior relationship executive, based in New York City.

“HSAs have arguably the strongest tax incentive benefit of almost any other corporate benefit offered to an employee,” Crain adds. “Contributions are pre-tax, and investment earnings are tax-free.”

Today there are about 10 million funded HSAs. That number is expected to double in two or three years, Crain forecasts. “I think of them [growing] like 401(k) plans did 20 or 30 years ago,” he says. Even Millennials are using the accounts early in their careers, the ML-Age Wave study found.

The rise in HSA popularity is attributed chiefly to employers aligning the accounts with 401(k) plans instead of with health insurance, as they did previously. Likewise, firms are actively promoting HSAs as an efficient way employees can save for the future. Earlier, employees treated HSAs as flexible spending accounts and therefore were prone to dissipate the moneys. In addition, companies are now linking HSAs to wellness programs, incenting workers to sign up for health screenings.

Pre-retirees about to be cut loose from employer group health insurance can obtain valuable advice from FAs who employ state-of-the-art tools to help them approximate the money needed for medical expenses as they proceed down the retirement path.

Further, HealthView Services of Danvers, Massachusetts, offers FAs proprietary software that not only estimates the Medicare surcharge implemented in 2007 but how to lower it by making specific changes to investment portfolios.

The tax, based on income earned, reduces an individual’s Social Security benefit.

“If your income exceeds $85,000 a year, you pay a 35%–36% premium on your Medicare [insurance] premium. It can be over 200%, depending on income. People are unaware of this surcharge. And [if they are], they don’t know how they can lower it,” says Ron Mastrogiovanni, HealthView president-CEO.

Vehicles such as Roth IRAs, 401(k) plans, non-qualified annuities and all forms of insurance, as well as health savings accounts, can reduce the surcharge because none is “means tested”; that is, they are not included in the individual’s modified adjusted growth income (MAGI), upon which the government bases this tax.

With the above products, “clients may save anywhere from tens of thousands of dollars to hundreds of thousands,” Mastrogiovanni notes. “And with an HSA, you don’t get hit with a minimum required distribution at age 70 ½.”

Another way to accumulate funds to cover health care is with an automatic savings system where withdrawals cannot be taken until retirement. This is ideal for individuals with little self-control around money, Pierce notes.

“It’s a pre-commitment device, a ‘constraint process’—metaphorically, you’re tying people’s hands. There’s a certain set that spends the money in their bank account as soon as they get it. The idea is to make sure that money never makes it into their account but instead goes automatically, directly to an investment.”

To pick up the slack in Medicare coverage, most retirees purchase supplemental health care plans from private insurance companies. The percentage paid by these plans—technically part of the Medicare program—varies from state to state. Each state negotiates pricing with vendors, approves the plans and administers them.

Thus, the locale in which a client retires can make a notable difference in health care costs for issues not covered by Medicare or for which the program pays little. Surprisingly, supplemental premiums in Hawaii are 70% less expensive than they are in Maryland, Mastrogiovanni notes. Florida, he says, is one of the priciest states.

Longevity insurance is a new savings vehicle that the government authorized last July. An advantage: Effectively a deferred income annuity, it isn’t means tested until the policy holder reaches age 85.

“So that’s another way of postponing getting hit with means testing until you’re a lot older,” Mastrogiovanni notes.

The possible need for long-term care in retirement should not be overlooked. Owners of long-term care insurance policies essentially buy a dollar amount they’ll be paid per day.

But “there’s no way to reduce the cost of these policies,” Mastrogiovanni says. “They are what they are. The only thing you can do is make the decision to buy a policy or to self-insure.”

“Isn’t it horrible that we have to deal with such a level of complication when we retire?” Mastrogiovanni remarks.

Agreed, but that’s where smart financial advisors can add real value.

No question, most clients, of their own volition, give little, if any, thought to saving for health care costs in retirement. It is therefore up to FAs to clue them in.

“But you need to have the [health cost discussion] in a way that doesn’t scare them,” Crain cautions. “A lot of 35-year-olds will think, ‘Oh, that doesn’t relate to me [yet].’ And people who are 44 to 55 don’t want to think about their mortality. So you need to tell clients that there are vehicles, such as HSAs, that aren’t painful in terms of their immediate finances. Advisors can explain that [HSAs] have a tax benefit, then [create] a retirement plan and help the client with the [spend-down]. It’s an incredibly rich conversation.”

Of course, one obvious way to handle medical expenses is to postpone retirement and stay covered longer by an employer’s group insurance plan.

But whatever your clients choose, one thing is certain: “Health care costs are a moving target. This isn’t something where you do a plan, one-and-done,” Kadish notes. “Clients’ situations may stay constant, but the things going on around them—whether health care costs or general inflation—keep changing.”

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