The missing link in most retirement plans

Few pre-retirees spend much time planning for health care costs in retirement, resulting in a dangerous financial gap in their retirement plans. That's one conclusion from a robust report, "Health and Retirement: Planning for the Great Unknown," which outlines the results of a study Merrill Lynch conducted in collaboration with Age Wave.

The report identifies two serious health-related threats that affect retirement:

• Unpredictable retirement health care costs, which now rank as retirees' top financial concern.
• Unexpected early retirement due to health problems.

To address these challenges, you'll want to take these two actions:

• Take care of your health. This will help you reduce the odds of incurring expensive and debilitating conditions, and enable you to continue working as long as possible. Health has also been identified by current retirees as the most important ingredient for a happy retirement.
• Have a strategy to pay for medical and long-term care expenses. Even if you do a good job of taking care of your health, these are still inevitable for most people.

And don't do one without the other!

Let's go into more detail regarding the second strategy.

Unpredictable health care costs

The report shows a clear gap when it comes to understanding health care costs in retirement:

• Only 15 percent of pre-retirees age 55 to 64 have attempted to estimate their health care costs in retirement.
• Only 7 percent of pre-retirees age 55 to 64 say they feel knowledgeable about Medicare coverage options, and only 19 percent of Medicare recipients say they're knowledgeable about Medicare offerings.
• Less than one out of six pre-retirees report having a trusted source to inform them of their Medicare options, long-term care insurance needs, or how to cover health care costs in retirement.

The best way to address health care costs is to buy medical insurance that will cover a substantial portion of potential medical expenses. Unfortunately, most employers don't offer medical coverage to their retirees. If you're lucky enough to be eligible for such coverage, often it's a good deal.

Once you reach the Medicare eligibility age of 65, it's possible to obtain affordable medical insurance. As a result, many pre-retirees say they'll delay retirement until then. Medicare itself will cover half to two-thirds of all medical costs, then it's best to buy some form of supplemental medical insurance that will fill in most of Medicare's gaps.

Before age 65, it can be expensive and difficult to buy retiree medical insurance, but it's nevertheless a critical part of any plan. One important goal of the Affordable Care Act was to make it possible for retirees under age 65 to be able to purchase retiree medical insurance. At this stage, it remains to be seen if the federal and state-run insurance exchanges will enable many early retirees to purchase affordable health care insurance.

It's essential that your retirement planning include learning about your options under Medicare and the types of insurance you can get to supplement it. Some financial planners are expanding their scope to include advice on Medicare and insurance plans. In addition, new advisory firms such as Sixty-Five Incorporated are specializing in delivering guidance on Medicare and insurance issues. These firms don't sell medical insurance, and they aren't affiliated with any insurance company.

The threat of long-term care

There's a big and important difference between medical care and long-term care. Long-term care is help with the basic activities of daily living such as dressing, food preparation, bathing and taking medications. Long-term care is commonly needed when an individual contracts a serious chronic condition or simply becomes too frail in their old age. Long-term care isn't considered medical care, therefore, Medicare and most medical insurance plans don't cover most long-term care expenses.

Everyone needs a strategy to address the possibility of needing long-term care because these expenses have the potential to wipe out your retirement savings and make you a burden on your family. Long-term care insurance is one effective way to protect yourself from this threat. But not many people buy long-term care insurance for a variety of reasons, often because the threat seems so far away and it's just easier to focus on your needs in the next few years. This approach can be a costly mistake.

Another way to address the long-term care threat is to hold your home equity in reserve. In this case, you'll want to resist the temptation to tap into it to pay for ordinary living expenses in retirement. If you eventually need long-term care, you can get a home loan or reverse mortgage to pay for your care, or sell your home to realize the profit.

If you never need long-term care, your home can serve as a legacy to pass on to children or charities. This strategy isn't perfect because it's possible to exhaust your home equity if you need long-term care for an extended period.

The Merrill Lynch/Age Wave report encourages you to learn as much as you can about your options to address the threat of health care and long-term care expenses in retirement, and to take actions to address these threats. For many people, this isn't a do-it-yourself project. You'll want to seek assistance from a trusted advisor who can help you make these critical decisions.