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How Health Care Will Crush the 80% Income Replacement Idea in Retirement

How much income does a retiree need to live a happy and healthy life? That’s a key question for financial advisors and their clients, and for many years, the answer has been between 80% and 85% of pre-retirement income.

Some experts like Michael Finke, coordinator of the doctoral program in personal financial planning at Texas Tech University, say that an 80% to 85% income replacement ratio, as it is known, is too high because, among other things, retirees spend less on transportation and no longer pay a 7.5% FICA tax for Social Security – if they were employees – or a 15% FICA tax, if they were self-employed. But Ron Mastrogiovanni, the co-founder and CEO of HealthView Services, which provides health care cost projections for financial services companies, says that ratio may be too low.

The firm’s latest HealthView Insights report, “Retirement Health Care Costs and Income Replacement Ratio,” notes that even those in the $250,000 income bracket may need to replace a larger share of their income for two big reasons: First, health care expenditures in retirement will be much greater than those expenses before retirement. In addition, health care inflation is running at about 6% annually, twice the average historical inflation rate.

“The stark reality is that health care is going to cost more than most retirees have saved using traditional IRR-based plans,” according to the report.

Not only are retirees likely to have more health issues than they had before retirement, but they will also be responsible for a larger portion of those costs despite Medicare. “Retirees are responsible for almost 100% of their health care costs,” [but] “IRR calculations use the same 25% figure that employees contribute for health care premiums,” according to the report. Employers pick up the other 75%.

The new Medicare “Doc Fix” law will subject more retired clients to the highest Medicare premium rates, but planning techniques…

Retirees will be paying premiums for Medicare Part B, which covers doctors’ services and outpatient care; Medicare Part D, for prescription drugs; and Medicare gap coverage, also known as supplemental insurance, which covers the copayments, coinsurance and deductibles that Medicare doesn’t pay.

That could cost retirees about triple what they paid for similar coverage as employees, according to HealthView Services: about $3,500 compared with roughly $1,200 for an HMO or $1,300 for a PPO plan (preferred provider) they contributed to as employees. There’s also no cap on out-of-pocket health care expenses for retirees as there is for most employees’ health care plans.

In addition, retirees with modified adjust gross incomes (MAGI) above $85,000 (for singles) or $170,000 (for couples filing jointly) are subject to separate surcharges for Medicare Parts B and D, the report notes. That could increase premiums for Medicare Parts B and D anywhere from 37% to over 200%, according to the report. This surcharge is separate from the 3.8% Medicare surtax that individuals with MAGI above $200,000 for individuals or $250,000 for couples have to pay as part of the Affordable Care Act.

Health Care Costs in Retirement for Singles. Source: HealthView Services

So what percentage of income should a person put away to finance their retirement after accounting for higher health care costs?

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