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Does the “4 Percent Rule” Hold Up for Retirement?

Planning to meet your future health care needs

By Ross Blair, CEO of PlanPrescriber.com

The Baby Boomer generation is now aging into Medicare at a time when health care costs are growing and there are questions about the program’s future. This raises concerns for a fast-growing population of seniors who are unsure if they’ll be able to afford health care once they retire.

On average, about 3.5 million baby boomers will age into Medicare each year for the next 17 years, which makes it critically important that boomers accurately anticipate their health care costs and choose the right health care coverage for their needs.

For decades now, William Bengen's popular “4 percent rule” has taught retirees that if they spend no more than 4 percent of their nest egg each year, their savings will last 30 years. But the rule may need some adjustment in light of today's economic reality. Depending on when you retire and how long you live, some financial experts are suggesting that a lower withdrawal rate might be necessary.

When it comes specifically to health care costs, here are some startling numbers from The Center for Retirement Research at Boston College:

  • $197,000: At age 65, a typical married couple free of chronic disease can expect to spend $197,000 on remaining lifetime health care costs, excluding nursing home care. However, this couple faces a 5 percent probability that these costs will exceed $311,000.
  • $260,000: Including nursing home care, the mean cost is $260,000, with a 5 percent probability of costs exceeding $570,000.
  • 15%: Less than 15 percent of households approaching retirement have accumulated that much in total financial assets.

To help manage health care costs in retirement, those 65 and older typically consider benefits like long-term care insurance and Medigap coverage. But anyone saving for retirement or nearing Medicare eligibility should be aware of the following issues:

Learn the basics of Medicare. Trying to understand Medicare can make anyone’s head spin. A recent survey by PlanPrescriber/Opinion Research Corp. found that 55 percent of baby boomers believe Medicare functions just like health insurance. However, Medicare differs from traditional health insurance in many ways, and there are some things that it doesn’t cover. Before you get inundated with sales pitches and unsolicited advice, try to understand the basics of how Medicare works.

There are three basic ways to cover yourself:

  • Original Medicare: This includes Medicare Part A and Medicare Part B (original Medicare), with a Medicare Part D (prescription drug) plan;
  • Medicare Advantage: Also called Medicare Part C, Medicare Advantage bundles parts A, B and D into a single plan managed by a private insurance company. These plans can include vision, dental and other benefits.
  • Medicare Supplements (also called MediGap): People who have original Medicare (Part A and Part B) can enroll in a separate MediGap plan to fill gaps in Original Medicare. It’s also recommended people enroll in a separate Part D plan.

Figure out what you can afford. It sounds simple, but if you haven’t estimated what your retirement income will be, start doing that math before you enroll in Medicare.

Calculate your income after Social Security benefits, pensions, IRA and 401(k) savings, etc. Then, create a list of monthly expenses including rent, utilities and food, as well as other things like your prescription drug costs. Subtract your expenses from your income to develop a good sense of what you can afford to spend on Medicare on a monthly basis.

Finally, look at your savings and think about how big of a deductible you could afford if you had a large medical expense. Once you know what you can afford each month and what you could afford in an emergency, you’re ready to start comparing plans.

Do side-by-side comparisons. If you want to make the most of your health care dollars, get the broadest possible view of all of your Medicare options. There are four “parts” to Medicare (A, B, C and D), plus ten Medicare supplements, each with their own costs, benefits and potential gaps.

The only way to really know if you’re making an informed decision is to compare plans side-by-side and make sure you understand what you’ll pay each month and what you would have to pay in a “worst-case” type of medical scenario.

The average Medicare beneficiary has 20 Medicare Advantage plans to choose from in their county. Rural counties average 13 plans, while urban counties average 22, according to Kaiser Family Foundation. Plans do vary by county due to cost and provider networks, so beneficiaries should review plan availability and benefits in their county by zip code.

In most states there are 10 standard types of Medicare Supplement plans, and about 20 percent of Medicare beneficiaries nationwide select this type of coverage. Each insurer decides how to set the premium for its Medigap policies. It can be set one of three ways: through community rating, issue-age rating or attained-age rating. How the premium is set will affect how much you pay now and in the future.

Comparing plans can be overwhelming, but there are online tools including www.medicare.gov/find-a-plan and www.planprescriber.com that can help simplify the process. Though it may seem overwhelming at first, taking the time to research your best option could really pay off and help ensure your nest egg will last as long as you need it.