Why You’ll Need More Dividends in Retirement
One of the major reasons investors choose a dividend-oriented approach in managing their portfolio is because they want a steady flow of dependable income. And many times, the goal is to build up that income stream for the investor’s retirement years.
A new report from HealthView Services Inc., a producer of health care cost projection software used by financial advisors as well as many others, signals that dividend-oriented investors and anyone planning their retirement income should probably increase their targets to account for larger-than-anticipated healthcare spending.
Higher Costs Coming
According to the report, health care costs are expected to rise by about 6% a year for the foreseeable future, not the 2.5%-3% annual rate that is generally used to calculate the general increase in the cost of living. That lower rate is what’s used by planners, plan sponsors and millions of investors to calculate what’s known as the Income Replacement Rate (IRR), the percentage of pre-retirement income someone would need in retirement to maintain the lifestyle of their working years.
“The most widely used range of income replacement ratios is 75%-85% of pre-retirement income. In fact, 80% is so widespread that it has evolved into a basic retirement planning rule,” the report states. “The figure is not arbitrary and has been the subject of a significant research and debate.”
But since health care costs are rising, an 80% IRR just won’t work.
Even the Affluent Will Need More
Because lower income households spend more of their income on necessities than more affluent households, it’s long been assumed that the IRR for low-income families is about 90% or higher. Now, because of the higher projected costs for health care, middle income and affluent families are likely to have higher IRRs than they did in the past.
HealthView points out that when people retire, they typically switch to Medicare from employer-sponsored programs, in which employers subsidize about 75% of the cost. Conventional IRR calculations assume that healthcare costs for individuals will continue at the 25% figure, but retirees are responsible for almost 100% of their health care costs. In one example, a 64 year old’s costs jumped from $1,245 to $3,563 — an increase of 186% in the first year of retirement — after switching from a company-sponsored HMO to Medicare.
Health care inflation, catastrophic health related events and long-term care premiums also will increase retiree health costs. And while out-of-pocket costs for working Americans under the Affordable Care Act are capped at $8,500 for an individual and $13,200 for a couple, those costs are unlimited for retirees, depending on their plan.
“The stark reality is that health care is going to cost more than most retirees have saved using traditional IRR-based plans,” the report concludes.
What To Do
HealthView’s solution is for today’s workers to increase their 401(k) contributions to make up for looming higher health care costs. The younger the individual is when they start saving more, the more modest the additional savings have to be; the magic of compounding will do the heavy lifting.
“Boosting 401(k)/Roth 401(k) contributions and benefiting from company matching; investing in a health savings account (HSA); annuities; life insurance; IRAs, and a Roth are the best strategies to not only address medical expenses, but also avoid means testing,” the report says.
When possible, choosing self-directed options within those structures will allow dividend-oriented investors to build a portfolio of income-generating stocks to help them pay for those higher retiree health care bills.
