retirement planning | july 13, 2023
Planning for Unexpected Health Care Costs in Retirement
Most retirees won’t experience an expense shock, but everyone should plan for it.
Key Points
The fear of a health care shock is pervasive, but data show that very few retirees experience a catastrophic increase in health care expenses.
While the likelihood of experiencing health care shocks increases with age, particularly for those 80 years and older, these increases are usually not permanent.
Retirees can take proactive steps to prepare for out-of-pocket health care expenses, because planning for the unexpected shouldn’t be left to chance.
Sudipto Banerjee, Ph.D.
Vice President, Retirement Thought Leadership
One of the unpleasant certainties of life is that everyone’s health will decline in old age. While some retirees might enjoy a long and healthy life and have a slow and natural decline in health, others may get diagnosed with a sudden terminal illness or have one or more chronic conditions, like diabetes or dementia, that require prolonged care. In addition to these possibilities, there are the risks of injuries from accidents and falls.
No matter what path a retiree’s health takes, one certainty is that everyone will experience some level of health care costs during retirement. While the routine costs of health care can be burdensome—some costs such as health insurance premiums and recurring prescriptions are easier to plan for—retirees are more concerned about an unexpected large medical bill.
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A number of studies (Banerjee, 20181; Poterba, Venti, and Wise, 20182) have shown that retirees are not spending down their assets as one might expect. Retirees may be hesitant to spend their hard-earned money in fear of or in preparation for these unexpected health care expenses.
In order to help retirees create a successful retirement income strategy that balances the need for current spending and future health care expenses, we need to better understand the likelihood and the magnitude of these uncertain health care costs. This paper will explore the probability that a retiree will experience a health care‑related financial shock as he or she ages and the chances of the higher expense becoming a new normal, resulting in higher future expense.
What Is a Health Care Shock?
There is no settled definition of what amount constitutes a health care expense “shock.” While shock is all relative to one’s financial situation, for our purposes, we focused on out‑of‑pocket health care cost increases of $2,000 or more during a two-year period.
What’s Included in These Health Care Costs?
Sudden large increases in health care costs are usually associated with out‑of‑pocket costs. These include costs associated with:
Hospital stays
Nursing home stays
Doctor visits
Dental services
Outpatient surgery
Prescription drugs
Home health care
Usage of special facilities (e.g., adult day care, physical therapy, social worker, transportation for elderly, etc.)
A catchall “other” category
Incidence of Health Care Cost Shocks
While the fear of experiencing a health care financial shock is pervasive, only a very small share of retirees actually experience such catastrophic shocks. Figure 1 shows the percentage of Americans age 65 and older who experienced a health care shock. Over two years:
10.9% experienced an increase between $2,000 and $5,000,
9.1% experienced an increase between $5,000 and $25,000, and
Only 2% experienced an increase of $25,000 or more.
Large Health Care Shocks* Were Less Prevalent
(Fig. 1) Percent of retirees who experienced a health care shock, by dollar ranges
*Health care shocks are defined as out-of-pocket increases of $2,000 or more in a 2-year period.
Source: T. Rowe Price estimates from Health and Retirement Study (2012–2018). Expenses are measured in 2022 dollars.
About Our Study
We used data from the Health and Retirement Study (HRS), which is a nationally representative survey of Americans ages 50 and older. The HRS has been conducted every year starting in 1992. We looked at people who were between 65 and 99 years old from 2012 to 2018. All costs are adjusted for medical inflation and expressed in 2022 dollars. Since the survey is conducted every two years, respondents report their out-of-pocket health care costs for the preceding two years. As a result, the increases reported are for two-year periods.
Given the vast size of the survey, data is released on a lagged basis and different sets of data are available at varying times.
1Sudipto Banerjee, “Asset Decumulation or Asset Preservation? What Guides Retirement Spending?” EBRI Issue Brief, no. 447 (Employee Benefit Research Institute, April 3, 2018).
2James Poterba, Steven Venti, and David A. Wise, “Longitudinal determinants of end-of-life wealth inequality,” May 2018.
Important Information
This material is provided for general and educational purposes only and is not intended to provide legal, tax, or investment advice. This material does not provide recommendations concerning investments, investment strategies, or account types; it is not individualized to the needs of any specific investor and not intended to suggest any particular investment action is appropriate for you, nor is it intended to serve as the primary basis for investment decision-making.
Any tax-related discussion contained in this material, including any attachments/links, is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding any tax penalties or (ii) promoting, marketing, or recommending to any other party any transaction or matter addressed herein. Please consult your independent legal counsel and/or tax professional regarding any legal or tax issues raised in this material.
The views contained herein are those of the authors as of June 2023 and are subject to change without notice; these views may differ from those of other T. Rowe Price associates.
This information is not intended to reflect a current or past recommendation concerning investments, investment strategies, or account types, advice of any kind, or a solicitation of an offer to buy or sell any securities or investment services. The opinions and commentary provided do not take into account the investment objectives or financial situation of any particular investor or class of investor. Please consider your own circumstances before making an investment decision. Information contained herein is based upon sources we consider to be reliable; we do not, however, guarantee its accuracy.
Past performance is not a reliable indicator of future performance. All investments are subject to market risk, including the possible loss of principal. All charts and tables are shown for illustrative purposes only.
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