Close Close
Popular Financial Topics Discover relevant content from across the suite of ALM legal publications From the Industry More content from ThinkAdvisor and select sponsors Investment Advisor Issue Gallery Read digital editions of Investment Advisor Magazine Tax Facts Get clear, current, and reliable answers to pressing tax questions
Luminaries Awards
Senior couple looking at documents

Retirement Planning > Spending in Retirement > Income Planning

4% Rule Falls Short for Retirees With Big Health Care Expenses

Your article was successfully shared with the contacts you provided.

What You Need to Know

  • Annual health care expenses tend to grow sharply toward the end of life, HealthView Services data shows.
  • Strategies that rely on a consistent rate of withdrawal may not be the best way to cover these growing costs.
  • HealthView Services argues that its automated system can help advisors keep retirees on track.

While retirees are grappling with inflation across the board, health care cost inflation is seen by experts as one of the biggest challenges facing older Americans who have left the workforce.

Adding to the sting of inflation is the fact that many older Americans find their health care spending needs grow sharply toward the end of life, whether due to hospitalizations for acute illnesses associated with advanced age or due to chronic conditions that require long-term care in a nursing home or clinical setting.

In fact, as explored in a new white paper published by HealthView Services, a couple on average can anticipate annual health care expenses of about $14,700 in their first year in retirement, and this grows to about $54,500 in the last year of retirement (at expected longevity).

Projections by Fidelity show a typical individual can expect to spend nearly $160,000 on health care and medical expenses through their retirement.

According to the new paper, these ballooning costs mean the 4% “safe” withdrawal rule and other fixed approaches to decumulation can fall short when it comes to the health care expense distribution curve. That is, when expenses spike toward the end of life, clients who haven’t prepared for this possibility could see their portfolio fall short.

A better approach, the authors argue, is to utilize more advanced planning techniques and automated liability-matching investing technology to help put retirees in a better position to meet their anticipated health care expenses — while also providing reliable income for the rest of their spending needs.

“Decumulation is arguably the most complex phase of retirement, with multiple factors including rising health care expenses, health-related events, portfolio performance and withdrawals all impacting the ability of a portfolio to meet future needs,” says Ron Mastrogiovanni, founder and CEO of HealthView Services.

Integrating more automation and proactive goals-based communication into portfolio management, Mastrogiovanni argues, provides a path for firms and advisors to efficiently meet clients’ decumulation needs at scale, all in a manner that is consistent with regulatory best interest requirements.

What the Data Shows

To develop its analysis, HealthView Services applied proprietary algorithms to 530 million actual health care claims (supplemented by government and private data) to provide health care cost projections for clients.

The data underscores that — driven by rising Medicare expenses, age-rating of supplemental insurance and increased use of services as clients age — health care costs will continue to increase faster than the rate of the consumer price index.

As a result, the firm warns, these expenses will account for a far greater portion of retirement budgets at the end of retirement than at the beginning. For an average 65-year-old couple, health care costs will require 45% of Social Security benefits; but, by the time they are 85, it will be more than 88%.

“For advisors and their clients, portfolio cash flows required to address these expenses need to track the retirement health care decumulation curve,” the paper suggests.

Planning Considerations

As the paper notes, in the run up to retirement, advisors’ primary objective is to ensure that clients will have the financial resources to meet their general and health care-specific needs in retirement.

“Projecting future health care costs and regular reviews to determine where a client stands against their accumulation goals are key to driving investments and savings,” the paper states. “Experience shows that when clients are provided with specific data about future health care costs, they take action — increasing investments or savings to ensure this need is met.”

In retirement, advisors and clients shift their focus to generating the income needed to match individually projected health care expenses.

According to HealthView services, there is a great opportunity for portfolio returns and principal withdrawals to be managed specifically around a health care-spending decumulation glidepath. The goal is to provide an optimal balance between risk, return and income goals to ensure the portfolio is ready to pay out increasingly larger amounts of income late in life to account for growing health care expenses.

“Since actuarial expectations provide a framework for planning, advisors need to discuss a range of longevity scenarios with clients using reliable data,” the paper argues, noting that HealthView Services has launched a Health Planner Plus solution that leverages actuarially backed health care cost projection data to track progress against accumulation and decumulation goals, while using a glidepath-driven approach to portfolio rebalancing.

“Our approach provides the flexibility to choose a zero balance in the health care portfolio at projected actuarial longevity or to plan for the potential that the client may live far longer,” the paper explains. “The automation built into the tools highlights the funding status of a portfolio to meet health care expenses based on a range of end-of-life expectations.”

The main planning concept is to optimize the balance between clients’ cash needs, portfolio returns and risk through retirement. The advisor can add even more value by factoring in choices around Social Security claiming, investment product selection and legacy planning.

Case Study

To demonstrate the power of this planning approach, the paper offers a hypothetical case study in which an advisor is using Health Planner Plus within their own asset management system.

The example is built around a theoretical investor named Marie, who is a 56-year-old unmarried woman who lives and plans to retire in New Mexico at age 66. She has been diagnosed with high cholesterol but has no other underlying chronic conditions and is not a tobacco user.

Marie provides her advisor with this information, which he uses to project her retirement medical expenses and life expectancy, the paper explains. She then fills out the advisor’s usual risk-tolerance questionnaire, which will help determine her portfolio’s asset allocation.

In the example, the results show that Marie is not necessarily risk averse, but she is willing to forgo some growth to reduce volatility. Based on the analysis, Marie is placed in a growth and income allocation pre-retirement with 60% in equity, 38% in bonds, and 2% in cash.

Marie and her advisor agree that the portfolio should be set up with a $10,000 cash cushion at retirement to give her peace of mind in case a health-related event requires access to additional funds.

Each year, the system informs Marie’s advisor whether she is underfunded, on track or overfunded to meet her projected future in-retirement health expenses. If she’s underfunded, it will also indicate the additional investment required to offset that gap.

Following an automated decumulation glide path, a gradual process of adopting more conservative asset allocations will be implemented as she ages, putting her in the position to fund her increasing projected annual health care expenses.

In the end, Marie’s retirement health care premiums and out-of-pocket costs are projected to be $357,751, plus the $10,000 cushion, which can all be covered with a one-time investment today of $93,794, the system shows.

Key Conclusions for Advisors

According to HealthView Services, financial professionals (who, on average, have over 100 clients) can save significant time and more efficiently manage their practice through the automated processes outlined in the new paper.

During the accumulation period, advisors are updated on a periodic basis on how their clients’ portfolios are performing relative to their retirement goals, and the system provides alerts on whether a client is behind, on track or even overfunded.

Throughout decumulation, asset allocation integrity is maintained, and the system makes the changes necessary to ensure that each client has the cash in their account to pay for annual health care expenses.

Ultimately, the paper argues, the key to achieving client goals is to leverage health care cost projection data to build savings pre-retirement in order to ensure that withdrawals can be made during decumulation to meet annual expenses.

“Whether through existing advisor-managed portfolios or with health care-focused portfolios from HealthView Services, the automation of this approach improves the speed and efficiency of advisor services, and helps clients take health care off the table as a retirement concern,” the paper concludes.

Photo: Adobe Stock


© 2024 ALM Global, LLC, All Rights Reserved. Request academic re-use from All other uses, submit a request to [email protected]. For more information visit Asset & Logo Licensing.