The new Medicare drug law that was enacted in late 2003 makes two changes that supporters of the law say should make it easier for today's workers to prepare to pay the medical bills they will confront in retirement: prescription drug benefits (the new Medicare Part D) and health savings accounts (HSAs).
This Issue Brief examines the impact of Medicare Part D on savings needed for insurance premiums to supplement Medicare, Medicare Part B and D premiums, and out-of-pocket expenses in retirement, and examines the viability of using HSAs to save for these expenses. It presents a wide range of estimates based on various ages at the time of death, because longevity risk is a major threat to retirement income security. This range of estimates also varies with various assumptions regarding health insurance premium inflation rates and out-of-pocket expenses.
The new drug benefit program (Part D) that will be available to those beneficiaries who elect Part B coverage could lower prescription drug spending, particularly for the growing majority that will not have employment-based drug coverage.
Health savings accounts will allow those who elect to purchase high-deductible health insurance to save up to several thousand dollars annually on a tax-free basis, particularly if none of the saved money is used to pay current expenses for health care services. But because of contribution restrictions, the amount of money that an individual can accumulate in an HSA is limited. An individual who contributes $1,000 each year starting in 2007 and makes catch-up contributions can accumulate $23,000 after 10 years, $47,000 after 20 years, $81,000 after 30 years, and $127,000 after 40 years.
HSAs will have a negligible potential benefit for those already 55 years old or older and would be structurally incapable of producing enough savings to substantially offset retiree health expenses. An individual age 55 in 2004 could save a maximum of $44,000 in an HSA by the time he or she reaches age 65. This is nowhere near enough money to completely pay for insurance premiums and out-of-pocket expenses in retirement. Specifically, an individual will need $137,000 if he or she only lives to age 80 and insurance premiums and maximum out-of-pocket expenses increase 7 percent annually.
Instead of choosing one assumption or the other, or an entirely different assumption, this Issue Brief provides estimates based on two assumptions for annual premium growth: 7 percent and 10 percent premium inflation. Additional analysis showing both lower and higher growth rates is provided in an appendix illustrates using 4 percent and 14 percent premium inflation instead of 7 percent and 10 percent.
Projecting the amount needed for medical expenses in retirement is tentative and complex because it requires conclusions about the range by which medical inflation will exceed consumer prices generally, as well as assumptions about whether medical practices will change in a way that makes Medicare coverage for a given ailment more or less likely.
