Your retirement health-care bill: $225,000

By MSN Money staff

As long as you're budgeting for retirement, earmark about $225,000 to cover your out-of-pocket medical costs. That's how much a typical couple retiring in 2008 will spend on prescriptions, deductibles and Medicare premiums, according to the latest study by Fidelity Investments.

That amount, considered the largest single expense for most people in retirement, increased 4.7% from $215,000 last year. Increases have averaged about 5.8% yearly since Fidelity began estimating costs in 2002. The amount does not include expenses such as over-the-counter medications, most dental services and long-term care.

Fidelity's study assumes that the couple will retire at 65, with a man living 17 years in retirement and a woman living 20 years. The estimate for health-care costs assumes that retirees do not have employer-sponsored retiree health care. It includes three typical costs: expenses associated with Medicare part B and D premiums (32% of the total); Medicare cost-sharing provisions -- co-payments, co-insurance, deductibles and excluded benefits -- (35%); and prescription drug out-of-pocket costs (33%).

Only about a third of large employers now offer health benefits to retirees, down from 66% in 1988, according to the Kaiser Family Foundation.

"Health-care costs have the potential to significantly erode an individual's retirement savings," said Brad Kimler, senior vice president of Fidelity Employer Services, a division of Fidelity Investments. "Knowing that these costs are only going to continue to increase, all Americans, even those as far as 20 years away from retirement, should be calculating and factoring lifelong health-care expenses into their overall financial planning."

Save thousands a year tax-free

One solution is to save specifically for health costs after retirement. A relatively new savings vehicle called a health savings account, or HSA, allows a family to make pretax contributions of up to $5,800 in 2008 (the amount is adjusted yearly). Earnings are tax-deferred. You'll pay no federal tax on withdrawals for health-related expenses after retirement, though the money can be used on a taxable basis for any purpose once you're past 65.

The catch? You have to buy a qualified health-insurance policy with a high deductible -- at least $1,100 for individuals and $2,200 for families in 2008 -- either through your employer or on your own. Any contributions you don't spend accumulate each year, unlike the flexible spending plans that most employers offer. And HSAs are portable if you switch jobs.

Because of the high deductible, most HSA-compatible policies are much cheaper than a conventional counterpart. A healthy San Francisco couple in their 40s with a child would pay about $496 per month for an HSA-compatible policy from Blue Cross of California, for example, and $1,120 for an all-inclusive HMO plan.

A separate study released in February by the Center for Retirement Research at Boston College estimated that an individual needs to enter retirement with about $102,000 budgeted just for health-care coverage, according to The Associated Press.

Updated March 6, 2008