How Healthcare Spending May Derail Your Retirement

Philip Moeller

No doubt you've read about the ability of unanticipated healthcare costs to decimate your retirement. We never think it will be us or a family member facing such misfortune. And even if we think we're good planners, it turns out that we consistently underestimate the costs of unforeseen medical problems.

Now, a major research effort by AARP provides projections on the size of medical bills that may await you. The big seniors' group launched a major project this week to support efforts to help reverse the economic damage experienced during the past several decades by the middle class, or what's left of it. As part of the effort, AARP commissioned nine studies on the major financial challenges facing middle-class consumers of all ages.

One of these studies deals in great detail with healthcare costs. We all know they are huge, that one of the objectives of Obamacare is to help control healthcare inflation, and that Congress will be wrestling with the same challenge for years. The AARP study looks past these soundbite headlines to examine in detail the portion of future healthcare costs that won't be covered by insurance or other benefits.

[Read: 10 Costs That Could Increase in Retirement.]

Researchers have given this cost category the warm and cuddly name of MOOP, which stands for Medical Out-of-Pocket expenses. But its impact is anything but friendly. Even with our best efforts to tame healthcare inflation, the study says, MOOP will ruin the retirements of millions of Americans and send millions of us into poverty.

Much of the research for the paper was provided to AARP by the Urban Institute. It looks at the future retirement prospects at age 70 of people as young as 25 today. There is growing concern about the ability of today's retirees to afford comfortable retirements. But the picture gets even worse for younger people. Here are excerpts of key findings of the report:

Medical expenses will wipe out the small retirement income gains for future retirees. When out-of-pocket medical expenses are taken into account, the median retirement income of future retirees (at age 70), net of health expenses, is expected to be about $27,000--the same as that of current retirees.

Projected declines in the poverty rate among retirees will be eliminated by increased healthcare costs. The poverty rate, as measured by this study, is projected to decline from 9.7 percent among current retirees to 3.4 percent among middle-income workers when they retire. However, after taking MOOP costs into account, the poverty rate will remain virtually unchanged--16.8 percent among current retirees and 16.4 percent among middle-income workers when they retire.

[Read: Will Healthcare Hurt Boomers' Retirement?]

MOOP expenses will take an increasing share of retirement incomes. MOOP currently averages $2,800 a year, which is 8.2 percent of income. Median annual MOOP expenses will be $5,600 per person, or 15.3 percent of income, for middle-income workers ages 45 to 54 (in 2012) when they are 70 years old. Those currently ages 25 to 34 can expect to pay $11,000 per person, or 19.7 percent of income at age 70.

Despite modest increases in income, today's working-age middle-income adults are less likely than current retirees to have enough retirement income to maintain their preretirement standards of living. When medical expenses are taken into consideration, the [income] replacement rate for current retirees declines from 80 percent to 70 percent (a 12 percent decrease). However, medical expenses are projected to further erode the retirement well-being of future retirees, decreasing the median replacement rate from 73 percent to 55 percent (a 25 percent decrease).

For younger generations that won't begin hitting age 70 until 2028, the cumulative impact of years of healthcare spending inflation will be dramatic. For all those who were 70 years old in 2012, healthcare spending totaled only 8 percent of their median household incomes. But for people now ages 25 to 54, such spending is projected to average 28 percent for those with low incomes, 18 percent for middle-class incomes, and 10 percent for people in the top third of all household incomes. At the extreme, healthcare spending will suck up 80 percent of the incomes of the poorest Americans.

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Here's a detailed look at the projected healthcare costs on people of different ages and income groups when they turn 70:

Median Household Incomes Spent on Healthcare
  Income Groups  
  Bottom Third Middle Third Top Third All Incomes
Age in 2012 25-54 25-54 25-54 70
Year Age 70 2028-57 2028-57 2028-57 2012
All 28% 18% 10% 8%
Retirement Income      
Lowest 20% 78% 39% 24% 21%
Second Lowest 20% 41% 25% 14% 14%
Middle 20% 30% 17% 10% 9%
Second Highest 20% 20% 12% 6% 6%
Highest 20% 10% 7% 4% 3%