Healthcare cost in Early Retirement

Paying for Healthcare Cost in Early Retirement

Healthcare cost in early retirement will be our largest expense.  Likewise it is the hardest expense to plan for given the uncertainties with the US government and increases in premiums.  The numbers seem staggering and only get more unbearable over time.  We want derive a number that we feel ok with to aid our planning.  We will try to get to some high level numbers in this post.

Want to hear a scary statistic?

The average out of pocket cost of healthcare for a couple at the start of 2016 for the standard retirement at age 65 is over $250,000.

WOW! This is a hard pill to swallow.  Historically these expense grow by about 6% per year.

To pay for healthcare cost in early retirement, risky assets are needed to cover the 6% hurdle rate equivalent to the rising cost of healthcare.

We already know the US savings rate is abysmal.  If you look at the chart linked here the US savings rate is hovering somewhere between 5 and 10 percent.  This is not enough to achieve early retirement.  This might not even be enough to fund healthcare expenses in standard retirement.

The number one reason my family still can’t completely commit to a life of early retirement is the cost of healthcare. For a few more years, at least one of us needs to be employed to have access to affordable health insurance.

When planning for early retirement, there are many uncertainties.  For instance, what will be our future benefit from social security?  This one is easy to plan for.  As someone who is 37 I plan my families benefit will be nothing, nada.  If we receive anything it will be considered surplus cash to play with.

The more difficult expense to plan for is the uncertainty of healthcare in this country.  We want to make sure our healthcare will be funded for the long term.

For the purpose of this post I am directing the conversation to aspiring early retiree’s with a net worth goal of somewhere between one and ten million dollars.  For those on the mid to higher end, they can  shift their assets to less risky investments for capital preservation and still generate more than enough to live well and cover the cost of healthcare.  But what about those on the lower end?  Risky assets are needed to do some heavy lifting.

How do I define a risky asset?

Overview of Risk Premium

Risky assets come with a risk premium.  I hope to not bore you with investing jargon, but a risk premium is the expected return of a asset over and above the risk free rate.

  • Risk Free Rate – the return you would expect to get from a asset that has basically no chance of monetary loss on the principal investment.  Great examples could be treasury bills or certificates of deposit.  Today the rate is somewhere around 1% to 3%, depending on your duration.  The ten year treasury bond has a yield of 2.19% as of the time of writing this.
  • Risk Premium – This is the theoretical expected return of the investment you are buying over and above the Risk Free Rate.

So if we take on some risk, we expect to generate a slightly higher return.  In 1952 a guy by the name of Harry Markowitz deduced something called the Efficient Frontier.

How Does Your Portfolio Rank on the Efficient Frontier

Here is an example of my early retirement taxable portfolio with a view generated by Personal Capital.  It is invested in 100% stocks.  The X marks the theoretical return of the stocks in my portfolio.  As you can see my portfolio is less risky than a 100% allocation to stocks.  The efficient frontier measures the standard deviation (risk) of the portfolio.

If I was invested in bonds, my return would lower but the anticipated volatility would be less.  I don’t necessary view volatility as a bad thing because we generally invest for the long term.  Study after study shows common stocks are less risky with holding periods of 20 years or more.

The point of showing this image is to illustrate the point that taking risk should lead to higher returns over time.  The longer your assets are compounding at high rates, the more likely you will be to increase your net worth and purchasing power to cover the ongoing healthcare burden.

How much should we plan for medical expenses?

So if we know that medical expenses are $250,000 and they grown at 6% per year.  How much money will you need to cover the cost?  How much money will we need to fund early retirement?

Some Assumptions

We have no idea how healthcare will play out over the long term.  The best we can do is make some assumptions based on what we know now and how the cost has increased historically.  If anyone has a better way to plan for this please comment below.

Healthcare Cost in Standard Retirement

Lets assume you are 37 and plan on retiring at age forty-five.  You will need at least 22 years of additional insurance premiums and out of pocket expenditures.  Then at 67 (for me) or whatever age you will qualify for full retirement from the US Government you will be in Medicaid and still fork out $250,000 in todays money to cover the rest of your life.

So lets makes some assumptions.  I will need 250,000 (growing at 6%) starting at age 67.  This means that in 30 years when we reach standard retirement age we will need $1,277,921.67 to cover the remainder of our out of pocket healthcare costs.  This is assumed that our healthcare cost is average.

We can achieve this by having $250,000 earmarked today for retirement expenses compounding at 6%. Hopefully we can eke out returns greater than 6% over time, but I think 6% is a conservative expected return.

Wow thats a large number.  The US really needs to get the cost of healthcare under control.

Healthcare cost in Early Retirement

We will also need to fund the 22 years of medical costs fully during early retirement.

I checked how much insurance costs on the open market in our area courtesy of the affordable care act website.  Three plan groups were offered bronze, silver and gold.  The average monthly premium today for a family of four in my area was $932, $990 and $1316, respectively.

When looking at specific plans there was one silver plan that looked right for our family offered through Kaiser Permanente.  It was offered for $1,134 in monthly premiums for a family of four.  It had a deductible of $7,000 and an out of pocket maximum of $14,300.  Lets assume we make the premium payments and reach the deductible amount every year for the next 22 years of early retirement.  I believe this is realistic with a family of four.  Lets also assume that this cost will grow 6%.  We are 37 now and will start early retirement at 45, 7 years from now.  How much will this portion cost?

  • In year 7 when we are 45: 20,461(premium) + 10,525(deductible) = 30,987
  • In year 8 when we are 46: 21,689(premium) + 11,157(deductible) = 32,846
  • and so on

This adds up to $1,344,589 in total dollars over the 22 years.

How to pay for this?

This is up for you to decide.

For us, we don’t want to spend down our principal in our early retirement investment portfolio.  That means we would need a dividend growth portfolio worth a little under $1,050,000 with a dividend yield of 3% pumping out $31,500 starting by the time we are 45 to cover the expense.  That dividend growth would hopefully increase by at least 6% annually matching rising cost of healthcare.

There are other ways of course.  Real estate might require less principal.  Part time job with benefits may help.  Or maybe we can hope for better healthcare in this country (although we’d never plan this way!)

I forgot mention Premium Tax Credits

The Affordable Care Act comes with tax credits based on your annual income. Should we assume these credits will still exist in  5, 10 or 15 years from now?  Will those income limits grow with the 6% hurdle rate? To estimate conservatively, I left out the tax credit on purpose for the following reasons.

  • Our income will likely be higher than the cap’s
  • The rules will most definitely change
  • We are overly conservative by nature

I found the following chart that shows the family size and income limits sourced from nerdwallet to qualify for the tax credits.

Conclusion

Healthcare cost in early retirement is a difficult expense to plan for.  We made many assumptions  to obtain numbers we feel slightly comfortable with.  I wouldn’t recommend using my numbers as the cost varies widely based on size of family, insurance needs, duration of early retirement and healthcare needs

We are still not confident in our ability to retire early now and pay for the burden of healthcare.   I welcome comments if you believe I am being overly conservative or missed something in my calculation. Healthcare will be our number one expense and simultaneously it appears to be the hardest o plan for.

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