Health Care Costs Clip Retirement Standard of Living for Most

The National Retirement Risk Index (NRRI) has shown that even if households work to age 65 and annuitize all their financial assets, including the receipts from reverse mortgages on their homes, 44% will be “at risk’ of being unable to maintain their standard of living in retirement. When recalculated to explicitly include the costs of health care, the number “at risk’ increases to 61%, according to the paper.

An analysis of the NRRI as updated to 2006 by age group indicates about 35% of Early Boomers (those born between 1948 and 1954) will not have an adequate retirement income. The share increases to 44% for Late Boomers (those born between 1955 and 1964), and to 48% for Generation Xers (those born between 1965 and 1974). Including health care costs, the NRRI rises to 50% for Early Boomers, 61% for Late Boomers, and 68% for Generation Xers, according to the report.

The authors explain that the NRRI calculates for each household in the 2004 Survey of Consumer Finances a replace­ment rate — projected retirement income as a percent of pre-retirement earnings — and compares that replacement rate to a target replacement rate derived from a lifecycle consumption smoothing model. Those who fail to come within 10% of the target are defined as “at risk.’ The original NRRI does not explicitly identify health care consumption, but incorporates it as a component of total household consumption in the process of calculating the target replacement rates, the authors said.

They explain that the implicit assumption of the NRRI is that spending on health care in retirement is substituted for other forms of consumption, such as food, wine, and travel. The report authors assume that an alternative, and probably more realistic, way to treat retiree health care expenses is as a “tax” that people have to pay in retirement.

The major health care expenses faced by retired households include premiums for Medicare Part B (which covers physician and outpatient hos­pital services) and Part D (which covers drug-related expenses); co-payments related to Medicare covered services; and health care services that are not covered by Medicare. The report projects that for single individuals retiring in 2010 the average required annuity to cover projected out of pocket health care costs is $102,966, and for couples it is $205,932.

The authors point out that the risk will be even worse for people who do not plan for health care expenses in retirement and for those who will require long-term care.

“The message of this brief is that it is critical for today’s workers to anticipate large health care expenditures in retire­ment and adjust their retirement and saving plans accordingly if they want to avoid a major reduction in their non-health care consumption. In addition to these financial planning decisions, individuals could also adopt healthier lifestyles in an effort to reduce their health care needs over the long term. The bottom line is that a little more work, a little more sav­ing, and a little more exercise could go a long way to strengthening retirement security,” the report authors conclude.

The CRR Brief is here.