Inflation and Retirement Health Care

Current U.S inflation is at a 40-year high and will affect one of the most significant expenses in retirement — health care.

Even a short period of high inflation will substantially increase future health costs. Financial advisors largely recognize the importance of incorporating health care expenses in the retirement planning process. The magnitude of those expenses is large, Medicare surcharges can have a significant impact on clients’ finances, and clients have a fundamental desire to ensure that their health care needs are met. But, in spite of the existence of protections like Social Security’s annual cost-of-living adjustment (COLA), some may be surprised at the extent to which inflation will affect retirees’ budgets.

Health Care Costs Rise Faster

The key is to understand the differential between consumer price inflation and health care inflation. Health care prices have historically risen 1.5 times to 2 times as fast as consumer prices. The 5.9% inflation-adjusted increase in Social Security benefits for 2022 was, for example, accompanied by Medicare Part B premium increases of almost 15%. The dramatic increase in Medicare premiums is a result of higher-cost goods, services, and wages, as well as greater utilization of medical services following the COVID-19 pandemic. The net result of this difference is that retirees have to pay more out of their pockets for health care. In the same way that compounding returns help grow retirement savings, the compounding differential between general inflation and medical inflation rates works against current and future retirees. Each annual increase in retirement health care expenses creates a higher cost base for the future. This means that even a short period of high health care inflation, followed by a return to historical averages of around 5.9%, will drive future costs higher and must be planned for.

Cost Scenarios

In a new white paper, we illustrate different scenarios to highlight the impact of inflation. Using conservative estimates for a healthy 65-year-old couple living to actuarial longevity, total lifetime retirement health care costs will increase by $85,917 if health care inflation is 11.85% for two years (or 1.5 times the current CPI of 7.9%). For an average 55-year-old couple retiring in 10 years, using the same inflation rate and period, costs will rise by $160,712. Total lifetime health care expenses for the 65-year-old couple, including Medicare Part B and D premiums, supplemental insurance, actuarially determined out-of-pocket expenses for hospitalization, doctor visits, tests, and prescriptions using the same scenario, are projected to be $683,306. And, for the 55-year-old couple, $1,094,460 for the exact same coverage. These totals do not take into account taxes or income-based surcharges. The totals do not include the cost of meeting long-term care needs.

Health Care Costs vs. Social Security

Consider what those costs look like when compared with projected COLA-adjusted Social Security benefits. Paying the average 65-year-old couple’s estimate total lifetime health care costs will require approximately 71% of future average Social Security benefits. For a 55-year-old couple retiring in 10 years, the percentage of Social Security required to cover health care is 93%.

Knowledge Is Power

Ensuring that clients can address their retirement needs starts with reliable data. Projected health care expenses depend on individual needs and circumstances. Variables such as income, time to retirement, gender, location, and health conditions all have a significant impact on actual expenses in retirement. The bottom line: This current period of high inflation will drive health care costs in retirement significantly higher. Retirement plans needs to reflect this, while at the same time factoring in other ways inflation will impact the savings and investment strategies required to achieve retirees’ goals.