Financial advisors, plan sponsors, and millions of Americans rely on income replacement ratios (IRRs) to estimate the savings that will be needed to generate a percentage of pre-retirement income sufficient to maintain their desired lifestyles in retirement.
A new HealthView Services white paper, unveiled today, shows that savings based on income replacement ratios risk falling short of meeting retirees’ goals because IRRs significantly underestimate future retirement health care costs.
“IRRs provide financial professionals with a streamlined, top-down approach of assessing retirement savings and income goals without having to calculate and project individual line-item expenses,” says Ron Mastrogiovanni, Founder & CEO of HealthView Services. “If they have saved for retirement using an IRR, most Americans assume they will have sufficient savings to cover their major costs. Many are in for a surprise when they find out that IRRs only cover aportion of estimated future health care expenses.”
The HealthView Insights paper, “Retirement Health Care Costs and Income Replacement Ratios,” highlights assumptions built into IRRs, reveals the shortfall in retirement health care savings when using IRR-based calculators and the additional savings required to close this gap.
The paper highlights two assumptions that underpin IRRs. The first is that pre-retirement income is a good basis for calculating income needs in retirement. When it comes to health care, the paper reveals this is not the case. IRRs also assume that household expenses in retirement can be projected forward using the general inflation rate of 2.5 percent to 3 percent. Since health care costs are expected to rise at approximately 6 percent a year for the foreseeable future, IRRs will fall short on the savings that will be required to cover healthcare.
“It will come as a surprise to many that upon retirement they will have to pay much more for health care than they did when working,” adds Mastrogiovanni. “In fact, most employees only pay around 25 percent of their actual health care premium costs, while employers pick up 75 percent. In their first year of retirement, for comparable coverage, they will have to pay out-of-pocket costs around three times what they paid as employees.”