Data & Research June 19, 2018

Planning for Health Care Costs in Retirement Is a Personalized Process

Vanguard has issued a new framework, jointly developed with Mercer, that helps pre-retirees and retirees with planning for annual health care costs and long-term care expenses in retirement.

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Vanguard has issued a new framework, jointly developed with Mercer, that helps pre-retirees and retirees better understand the financial planning implications of annual health care costs and long-term care expenses.

The research paper, “Planning for healthcare costs in retirement,” outlines key health care cost factors and personal considerations, as well as frames health care expenses as an annual cost rather than a lifetime lump sum. “Most analyses available in the marketplace today point to a daunting out-of-pocket healthcare expense over the lifetime of a retiree. These large dollar values can be demotivating for investors from a psychological and behavioral perspective,” Jean Young, co-author and senior research associate in the Vanguard Center for Investor Research, says. “Instead, our model focuses on the more manageable task of planning for incremental, annual healthcare costs, while separately considering and integrating the potential for long-term care expenses.”

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Based on the joint analysis, Vanguard recommends several important changes to the way health care costs are typically discussed and modeled, and recommends that investors focus on five key areas: health care cost factors, replacement ratios, annual cost framing, substitution effects, and long-term care.

According to Vanguard, one of the most impactful inputs in understanding potential costs is the volume of health care services a person may consume in retirement, which can be estimated based on pre-existing chronic conditions and family health history. Another significant influencer on out-of-pocket health care costs is the type of Medicare coverage that a retiree selects, and whether their income dictates additional surcharges. Individuals retiring before age 65 will need to have a financial strategy to bridge their health care coverage until Medicare eligibility begins.

Due to the variations in a person’s life and health status year over year, the research encourages investors to focus on factors they can control and plan accordingly using the following guidelines:

  • Understand costs. Individuals should understand how their health status and other personal factors might affect their annual health care costs. Coverage choices should be informed by health status, retirement age, and income.
  • Understand employer subsidies. Individuals should understand the difference in the health coverage cost they pay now with the help of any employer subsidies, and what they will have to spend in retirement. Having a clear picture can help avoid potential “sticker shock” and better prepare retirees for their out-of-pocket health care expenses.
  • Target higher replacement ratios. Some retirement savers may encounter a large incremental change in health care costs when they retire due to the loss of generous employer subsidies or declining health, and may want to save at higher rates now to offset these factors in the future.
  • Consider health savings accounts. Health savings accounts (HSAs) can be used as a means to save, in a highly tax-efficient manner, for unforeseen health care expenses in retirement. Investors can save in these accounts today, and reduce the impact of future health care costs by having earmarked tax-free savings.
  • Weigh Medicare enrollment options carefully and revisit annually. Decisions involving the choice between traditional Medicare coverage only, traditional Medicare with a supplement, or Medicare Advantage depend on each retiree’s needs and circumstances. Retirees should assess their situation each year and make adjustments accordingly. However, the opportunity to adjust may be limited.

Long-term care costs

Long-term care costs represent a separate planning challenge given the wide distribution of potential outcomes, Vanguard notes. Half of individuals will incur no long-term care costs—but 15% could incur expenses exceeding $250,000. Even if the probability is low, Vanguard encourages retirees to confront the possibility of an extended, expensive long-term care stay, given the magnitude of the potential cost.

Retirees should first consider unpaid care options such as family support and acceptable types of paid care, as well as Medicaid rules should resources be depleted, the research paper suggests. Funding for long-term care expenses can take many forms, with the biggest resource being private, out-of-pocket spending.

In building a framework for retirement, individuals should have assets that serve as a source of annual income, as well as a contingency reserve to cover long-term care costs or other unexpected expenses. Additional considerations can include home equity, and income annuities for surviving family members.
Client Service June 19, 2018

Considerations for Helping Terminating and Retiring Participants

“If a plan sponsor can invest in an adviser or other person to provide direction for terminating or retiring employees, that would be extremely helpful,” Terry Dunne, from Millennium Trust Company, told 2018 PLANSPONSOR National Conference attendees.

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“The number one duty of defined contribution (DC) plan sponsors is to act for the best interest of plan participants. And, beneficiaries and terminated employees are still participants,” Jamie Greenleaf, lead advisor and principal at Cafaro Greenleaf, pointed out to attendees of the 2018 PLANSPONSOR National Conference.

Terry Dunne, senior vice president and managing director of Retirement Services at Millennium Trust Company, added that when plan sponsors spend so much time and energy trying to create a retirement plan, they should not just focus on the specific period of time when someone works, but also for when someone retires. “Make sure you are doing as much as you can for participants when they retire or leave work,” he said.

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Dunne noted that the Department of Labor (DOL) and the Securities and Exchange Commission (SEC) efforts to create conflict of interest standards are focused on the adviser community to make sure advisers are going to present opportunities, investments or IRAs in the best interest of participants—making sure costs are not too significant and investments are not too risky, and there is a proper level of diversification in investments for retirees or terminated employees.

Greenleaf pointed out that these regulations and discussions around them have put the focus back on participants—the end user of the plan. Some plan sponsors didn’t know they were fiduciaries until this discussion, she said.

She suggested that retirement plan committees put together a mission statement, hopefully looking at the plan as a retirement benefit—not just addressing the accumulation phase, but also the decumulation phase. “Look at distribution options and investments that are optimal for those near and in retirement,” Greenleaf told conference attendees.

Dunne added that plan sponsors should think through carefully what to do if a participant is leaving employment. Plan sponsors need to improve their communications and make terminating participants feel they are well-advised and understand what their options are. Plan sponsors should also encourage individuals to stay connected with the company if they leave their assets in the plan. “Just turning decisions over to participants at the time of termination or retirement without guidance can hurt their retirement success,” Dunne said.

Assets left in the plan can drive overall costs down, but when an employee leaves the company, plan sponsors have less contact with them, and fiduciary duties to provide notices becomes more difficult if the plan sponsor loses track of them, Greenleaf noted.

Dunne said “missing” participants are not really missing. Plan sponsors just need to use the right tools to find them.

Tools for second phase in life

Protecting DC plan participants from themselves so that they can be better prepared for retirement post-employment means protecting the benefits the plan sponsor is trying to provide for them, according to Greenleaf. She said the retirement plan committee needs to reduce the potential for plan leakage—reduce the number of loans participants can have, increase the interest paid on plan loans, and do not allow age 59 ½ in-service distributions, for example.

Greenleaf also questioned why terminated participants with a balance less than $1,000 are treated differently than those with a balance between $1,000 and $5,000. She suggested plan sponsors rollover, rather than cash out, balances less than $1,000 to keep participants’ investments protected for future use. “Hopefully the participant will decide to move the money to a new employer’s plan,” she said.

Regarding the plan leakage issue, an attendee suggested plan sponsors let terminated participants take loans from the plan so they are paying back money into the plan, as well as allowing participants who terminate to repay loans after termination.

Dunne said his firm is seeing larger plan sponsors implementing sidecar individual retirement accounts (IRAs), creating an opportunity for individuals fully contributing to the plan to continue to contribute towards retirement if able.

He also pointed out that there is so much conversation among legislators and regulators to encourage people to have guaranteed income. “I think it will take a few more years for things to happen, but there is movement in that direction. Participants are interested in that. We need to create a [defined benefit] element for DC plans for income in retirement,” Dunne said.

In the meantime, Dunne suggested plan sponsors provide information, education, and calculators to help participants turn their DC assets into income in retirement. “If a plan sponsor can invest in an adviser or other person to provide direction for terminating or retiring employees, that would be extremely helpful,” he said.

Greenleaf added that engaging retirement plan participants is difficult, but engaging them at retirement is a lot easier because it is relevant and meaningful to them. She suggested plan sponsors hold education meetings specific to the participant group close to retirement, focusing not only on what to do with DC plan assets, but about Social Security and Medicare.

Responding to an attendee question about handling uncashed checks of either required minimum distributions (RMDs) or cashouts of low balances, Dunne reiterated that there are many tools to search for “missing” participants.

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