Seniors' Out-of-Pocket Health Costs Can Hit $350K, Even With Medicare

A man looks over the Affordable Care Act signup page on the website in New York in this October 2, 2013 photo illustration. Reuters

This article originally appeared on The Motley Fool.

As you get older, your need for healthcare will increase—and your costs will rise along with your demand for services. While you may assume Medicare will cover your healthcare expenditures, the truth is that Medicare isn't as comprehensive as most people think it is. There are co-insurance costs and gaps in coverage that can force seniors to pay out of pocket for many services. Sometimes, these costs can be astronomical. If you require lots of costly prescriptions and you want a 90 percent chance of being able to pay all of your out-of-pocket healthcare costs, you may need to save $349,000 per couple, according to a new report from the Employee Benefit Research Institute.

Saving enough to cover your healthcare costs is vitally important to ensure that higher-than-expected healthcare bills don't derail your plans for a financially secure retirement. But costs can vary widely, so how much money do you actually need saved up to cover the costs of care?

Saving for retirement

Predicting the amount of money you will spend on healthcare costs during retirement is a challenge, because your life expectancy and future health needs are unknown. A new report from the Employee Benefit Research Institute (EBRI) can help.

The report was prepared using a simulation model that assumed the purchase of a Medigap plan. It included in its estimated care expenses premiums for Medicare Part B and Part D, premiums for Medigap, and out-of-pocket spending on prescriptions and other costs not covered by Medicare and Medicare supplemental plans. EBRI also assumed expenses would be incurred over time, so it assumed your savings could be invested at an interest rate of 7.32 percent until care expenses are incurred.

Based on these assumptions, if you turned 65 in 2016, here's how much seniors might need to have saved to cover healthcare costs at different genders and levels of prescription drug use:

  • A man with median drug expenses will have a 50 percent chance of being able to pay his medical bills if he saves $72,000 for healthcare. The same man would need to save $127,000 to have a 90 percent chance of covering his healthcare costs.
  • A man whose drug expenses are in the 90th percentile will need to save $97,000 to have a 50 percent chance of covering his healthcare expenses—and $168,000 to have a 90 percent chance.
  • A woman with median drug expenses will need $93,000 to have a 50 percent chance of covering her healthcare costs, and $143,000 to have a 90 percent chance.
  • A woman with drug expenses in the 90th percentile will need $124,000 to have a 50 percent chance of covering her healthcare costs—and a whopping $187,000 to have a 90 percent chance of paying those bills in full.
  • Finally, a married couple with prescription drug costs in the 90th percentile will need $349,000 to have a 90 percent chance of being able to pay for medical care.

Because some people get much sicker and thus consume more healthcare services, the target savings amounts vary widely. If you want to ensure you have the money you need, it's best to assume the worst when setting your savings goals.

Why are these costs so high?

Based on these target goals, a married couple should aim to set aside about $349,000 for healthcare costs during retirement in case either or both partners develop a costly or chronic condition. And yes, this is a lot of money.

Unfortunately, costs are high for many reasons, most of which you cannot control.

First, Medicare only pays for around 62 percent of out-of-pocket healthcare costs, and private insurance pays for 13 percent of expenses, on average. Retirees pay out of pocket for around 13 percent of the costs of care they need, which can add up quickly with an event like a heart attack—which could top $760,000 in costs, even if the attack is not severe.

Seniors are also limited in the amount of supplemental coverage they can purchase. For example, it's typically impossible to completely avoid cost-sharing and deductibles associated with outpatient prescription drug use—and seniors are major consumers of prescription medications. While seniors 65 and older account for 13 percent of the population, they are responsible for more than 33 percent of total spending on prescription drugs.

How can you save to cover care costs?

The best way to save enough to cover healthcare costs is to open and invest in a health savings account (HSA) as soon as possible in your working life.

If you have a health insurance plan with a deductible of at least $1,300 for self-coverage or $2,600 for family coverage, you are typically permitted to invest in an HSA. The annual contribution limits are $3,400 for individuals and $6,750 for families. If you're 55 or older, you can make an additional $1,000 annual catch-up contribution.

Money is invested in an HSA pre-tax, and you can purchase a wide variety of investments in your HSA account. You cannot contribute to the account once you're on Medicare, but you can take money out to pay for co-pays, care deductibles, dental costs, and Medicare (but not Medigap) premiums.

You should also start saving in tax-advantaged retirement accounts as early as possible. Having a big retirement nest egg will provide you with a cushion to cover high medical care costs. If you get lucky and don't need your savings to cover medical care, you can pass the account on to your kids.