How to Calculate your Healthcare Expenses for FIRE (or Entrepreneurship)
Photo by Derek Finch on Unsplash
The TL;DR
What is it?
The FI Healthcare Cost Calculator estimates the health expenses for each year of the rest of your life and determines how much money should be in investments today to cover all those years.
Who is it for?
For early retirees, people who are doing financial planning, or entrepreneurs.
Why was it created?
Up until now, there hasn’t been a good way to calculate how much savings are needed to cover health expenses for the rest of your life. Calculating healthcare costs in a confusing landscape with an unknowable future can be a daunting task. The FI Healthcare Cost Calculator takes into account many significant factors that ultimately affect your FI number.
Disclaimer: This article and calculator is hypothetical and does not represent the return on any particular investment. The rate is not guaranteed. All investing is subject to risk, including the possible loss of the money you invest. Information and interactive calculators are made available to you as educational tools for your independent use and are not intended to provide financial planning or investment advice. These tools help you see which factors are most important to consider in making a particular financial decision, and they illustrate the relative impact of each factor on the projected outcome. We cannot and do not guarantee the accuracy of the results or their applicability to your individual circumstances.
Motivation
Healthcare expenses can be frightening. In a more extreme example, the cost of cancer treatment can exceed $1 million dollars. Relative to typical financially independent (FI) nest egg sizes, these costs could be financially catastrophic if paid entirely out of pocket. Health insurance provides a way to protect our finances from these low probability and high impact events. Unfortunately, the cost of health insurance and out of pocket health expenses are poorly understood and rarely discussed. This leaves many people with the default approach of multiplying their current out of pocket health expenses from expense tracking tools like YNAB, Mint, or Personal Capital by a safe withdrawal rate to ensure they have enough in investments to cover health expenses for the rest of their life. This simple approach is inherently flawed because it leaves out many significant factors that differ from normal expense projections and could lead to a much different FI number. For example:
Many people interested in financially independent retire early (FIRE) planning are in their 20s and 30s and haven’t realized many health expenses so the simple safe withdrawal calculation approach would assume they always stay this healthy.
Spending in retirement tends to go down each year as a person ages, but healthcare spending tends to go up.
Maybe your friends and family near traditional retirement age complain and warn about high healthcare expenses. Are their costs somehow higher than yours for similar coverage and service?
Healthcare spending is very lumpy. For example, did you just welcome a new baby into your family and want to FIRE, but your annual spending on healthcare just shot up?
Your employer may be “providing” or “subsidizing” healthcare, so how much is that hidden cost when you are in charge of the bill?
Are any health expenses like employee premium and health savings account (HSA) contributions withheld from your paychecks and absent from your expense tracking software?
The power of investing and compound interest is huge, so are high health expenses 40 years from now easy to cover if I start investing for them today?
Healthcare inflation is possibly higher than normal inflation, so are health expenses 40 years from now going to destroy your finances?
If my income goes down once I FIRE, then will I get subsidized insurance?
Are your healthcare costs going to change significantly if you geoarbitrage or move to another state once you FIRE?
Is there a way to estimate this and is there hope? We think so.
How can we possibly predict an unknowable future? Should your FI planning set aside 10s of thousands, 100s of thousands, or millions of dollars in investments to cover health expenses for the rest of your life? That’s the question a diverse team of FI enthusiasts set out to answer at CampFI Rocky Mountain 2022.
The group included individuals spanning many different ages, pre/post FI, states of residence, income levels, and household makeup. It included nurses, engineers, mathematicians, accountants, and teachers, all of which are motivated to solve this problem and to share the solution. This collaboration brings you the FI Healthcare Number and Calculator.
Planning Your Independence with the FI Healthcare Number
The FI Healthcare Number calculates the amount of money that should be invested to cover the cost of health expenses for the rest of someone’s life. To get your total FI Number simply: 1) add up your current annual expenses excluding any expenses related to health insurance premium, deductible, or copays; 2) divide this “everything but healthcare” annual expense number by your safe withdrawal rate; and 3) add the FI Healthcare Numbers for everyone whose health expenses you want to cover. The FI Healthcare Number is calculated easily using the interactive calculator at FIHealthcare.com. But how does it work?
FI Number = FI Number Excluding Healthcare + FI Healthcare Number
How the Calculator Works
The FI Healthcare Cost Calculator estimates the health expenses for each year of the rest of your life and determines how much money should be in investments today to cover all those years. Let’s take the example of a 35 year old who wants an FI plan that would cover them through age 100. The calculator first takes the annual health expenses for a 35 year old this year to estimate what a 36 year old would have paid this year (spoiler alert - they aren’t the same). Then that theoretical expense for a 36 year old this year is projected to next year by adding 1 year of healthcare inflation. We now have an estimate of how much healthcare will cost them next year when they are 36 years old.
Next, we use a nominal return on investment (which includes normal inflation) to calculate how much money needs to be in investments this year so it will grow for one year and cover the health expenses we calculated for next year. We now have the age 36 contribution to the FI Healthcare Number. Up next is age 37, the formula adjusts premiums for a 37 year old, projects forward for 2 years of healthcare inflation, projects back for 2 years of investment growth and adds today’s investment value to the FI Healthcare Number.
Last, this process is repeated for age 38, 39, etc. up to the age someone goes on Medicare. The calculator then uses a similar approach projecting to the future and back to the present to calculate investments needed to cover healthcare expenses while they are on Medicare up to age 100. So, how do we estimate today’s health expenses so the calculator can do it’s magic both before and after Medicare? That is the goal of our calculator.
Calculating Annual Expenses for Your Traditional Healthcare Years (Pre-Medicare)
Annual expenses for your traditional healthcare years includes annual premiums for just the insurance policy, then out of pocket spending until you hit your deductible, and then co-insurance/co-pay spending until you hit your out of pocket maximum. Let’s start by looking at the insurance policy premium.
There is a lot of societal change happening today to attempt to dismantle discrimination based on race, sex, age, disability, orientation, identity, and religion. It can seem natural to assume that something as heavily legislated as health insurance wouldn't be able to vary based on any of these protected classes, but health insurance premiums are often a function of age.
Age variation can be difficult to find. If family and friends 1 or 2 generations ahead of you in life are commenting on the high price of healthcare, it’s not just that they may have more medications or doctor visits. The health insurance premiums for identical health insurance coverage this year can be significantly higher for a 64 year old than a 21 year old, up to 3x higher (per 45 CFR 147.102(a)(1)(iii)).
Our calculator takes this 3x nominal age variation into account by projecting what the age-inflation factor would be for each year in the future based on your current age when you got your premium estimate and the age you would be in each future year. So let’s take a closer look at your health insurance coverage and premiums this year.
Employers negotiate health benefits with insurance companies and may subsidize a large portion of health insurance premiums, making it difficult for employees to see their true healthcare premium costs. The remainder of the premiums are deducted from employee paychecks so even the reduced premium may never hit your expense tracking tools like Mint, YNAB, and Personal Capital. Similarly, Health Savings Account or Flexible Spending Account contributions may be withheld from paychecks and tracked in accounts separate from your normal expense tracking. These effects are financially beneficial to you as an employee, but they can create significant blind spots in your FI planning and make you “dependent on your job for the benefits”. So what are health insurance premium costs for early retirees?
Your current out of pocket annual premium cost is highly dependent on many factors specific to you including desired coverage level, coverage network, household makeup, age, income, smoking status, and where you live. To estimate what your costs would be, you can go to healthcare.gov which will take you to your state specific marketplace. An alternative to this that we are currently favoring is healthsherpa.com which is a private partner to healthcare.gov and seems to have a better user interface. Enter your specific information and select a coverage and network that you would like to run in the calculator at healthcare.gov or healthsherpa.com. Write down the annual premium, annual deductible, and annual out of pocket maximum for your selected plan. The premium is a fixed cost so it’s easy to account for in the calculator, but the deductible and out of pocket maximum will require some thinking about the level of health services you plan to use.
Your in-network health bills each year will be paid 100% out of your pocket until your deductible is met. After that, you will pay co-insurance and/or co-pays for a portion of the health bill (eg 20% in the case of co-insurance for a flat amount like $30 in the case of co-pays).
When the amount of deductible and co-insurance you have paid out of pocket each year reaches your out of pocket maximum, all further health costs that year are paid 100% by the insurance company. Unfortunately, this is fairly complex conditional bookkeeping, because your expenses for a health service or product depends on how much you already spent that year. To complicate things further, different expenses may have different co-insurance and we don’t even know what medication or health services we may need 30 years from now.
So, rather than itemizing a bunch of expenses and trying to match them up to coinsurance and guess at future discrete expenses, our calculator uses a simpler approach. Although there are many ways your annual health expenses could play out for each year you have left, the calculator models them in two possible annual outcomes. Either you will have a typical “healthy” year with some ongoing baseline health expenses (eg daily medication, annual physical, and two specialist visits), or you will have a year with an event (eg accident, surgery, birth, etc.) that causes you to hit your out of pocket maximum.
The calculator will have you enter the frequency of the out of pocket maximum events you want to assume (eg 1 out of every 5 years). If you have an expensive chronic condition or medication you might plan to hit your out of pocket maximum more often (eg 1 out of every 1 years in very extreme cases and the vast majority of people will never get close to this since even for a catastrophic medical situation, those generally last a few years). Anecdotally, the site’s owner, Lynn Frair, had a brain tumor and had to learn how to walk again. She hit her out of pocket max for 3 years out of the last 25. On the years when you don’t hit your out of pocket maximum, the calculator will assume you use a percent of your deductible that you estimate as a baseline “healthy” year.
Last, an average annual healthcare cost is determined using the age scaling, premium, deductible, out of pocket max, out of pocket max event probability, and baseline deductible percent spending. This annual healthcare cost is adjusted for healthcare inflation and age based premium scaling and a seed investment amount is added for each year of your life until you reach your medicare age.
Calculating Annual Expenses for Your Medicare Years
The average annual healthcare expenses for an individual on Medicare with supplemental coverage was estimated to be $7,500 per year, per person. In our equation we opted for an average annual spend estimate assuming you were of medicare age this year that is then increased based on healthcare inflation to estimate healthcare costs for each year starting at your medicare age. This cost is intended to cover all in-network out of pocket expenses including supplemental insurance premiums, deductibles, co-insurance, and medication. Using the average annual expense across medicare enrollees of all ages should be a little conservative since your utilization of health services and corresponding spending will likely skew towards when you are older and have more time for your investments to grow.
Putting it All Together
A lifetime of healthcare expenses is usually large, complicated, non-discretionary, and driven by many things out of our control like healthcare inflation, legislation, and future ailments. This can leave you feeling powerless when trying to do long term financial planning related to what may be the most important and substantial expenses in your life. Although this future can’t be predicted, individual scenarios can be analyzed. The FI Healthcare Cost Calculator estimates how you should adjust your FI planning to account for the complicated world of healthcare costs. Although it generates a single number for a single input scenario, its real power is the ability to rapidly calculate how different scenarios require different size investment nest eggs. What if you move to a different state? What if you added a new dependent to your life? What if healthcare policy changes? What if changed to a gold, silver, or copper plan? What if healthcare inflation rates change? What if you get a chronic illness tomorrow and hit your out of pocket maximum each year for the rest of your life? Use the tool to explore the magnitudes of healthcare costs in these different scenarios and see for yourself which scenarios your plan can support, which are driving you to change your plan, and which you would want to re-plan for should they occur. Then stop stressing and move forward with living your life and enjoying the health you have today. ☺️
For the math-oriented, here is the formula the calculator uses:
Lynn’s Note: A Message of Hope from FI Healthcare
The larger picture is that calculating healthcare costs in a confusing landscape with an unknowable future can be a daunting task. The calculator attempts to estimate the magnitude of this problem and in spite of high healthcare costs, there is actually quite a bit of hope long term. There is hope that people will find healthcare cost inflation unsustainable at some point and will work to find efficiencies and bring it under control. There is hope that if costs change, they can be recalculated and you will have, likely, many decades to figure out a new plan. Life was unpredictable before leaving traditional work to pursue entrepreneurship or early retirement and it will be unpredictable after and the solution is surrounding yourself with wise problem-solvers like those who would read an article such as this. There is hope that in many cases you will end up with more money set aside for healthcare that you may not use. The reality is that there is a chance that you will run out of money, but there is also a chance that you will run out of life without doing the things you dream. Many of you have unique gifts that can be added to the lives of others, but cannot be expressed without unhinging from a more traditional path. Each person in the FI community or in the entrepreneur community has gifts that cannot be expressed until you begin to look, with hope, at a different path.
Author’s Note: Effects Outside of this Calculation Currently
The calculator allows us to start ballparking how much we need allocated in investments to provide lifelong healthcare. There are a number of effects that are not included in this calculation for simplicity. You may want to keep these effects in mind when planning your financial independence or entering values in the calculator based on your risk tolerance and world view. These are also good candidates for future upgrades to the calculator, please reach out to FIHealthcare if you want to volunteer to help.
“Health” expenses outside of in-network health insurance and medicare. The calculator is focused on the costs of premium, deductible, and co-pays until out of pocket maximum for in-network health expenses. Anything out-of-network or that you might categorize as a “health” expense, but wouldn’t count toward your in-network deductible is not covered by your FI Healthcare Number. For example, massages or your gym membership would be examples of expenses most likely not covered by health insurance. Also, long term care is a separate major late life expense covered by its own insurance and planning.
Sequence risks. The calculator assumes that healthcare inflation and nominal return on investment occur at a fixed rate when in reality they can vary greatly year to year. It also averages out the “lumpy” nature of health expenses by using a weighted annual expense when people may pay a lot out of pocket in years with major life events and little out of pocket when they have a healthy year. Last, it doesn’t include any actuarial tables and simply asks for a death date. A more complex model would use monte-carlo analysis or backtesting type methodologies to account for sequence of health expenses, sequence of return, death probabilities in a given year, and inflation variation to give a probability or confidence that your investments will cover your health expenses over the rest of your life.
Chronic health issue onset. A sudden chronic illness could cause the underlying spend rate to change suddenly and forever. Medication and ongoing doctor visits to manage chronic illness could shift your assumptions. Coming back to the calculator if your typical deductible and out of pocket max shifts significantly may be advised. If you are more conservative, then weight these effects more effectively or get a sense of costs at the extreme end by assuming you hit your out of pocket max every year.
High fidelity medicare calculations. Medicare is complicated with its supplements so this calculator opted to assume an average annual medicare out of pocket spend. Breaking this down into more detail like the pre-medicare calculation could be an area of fidelity improvement.
Less common forms of healthcare. The calculator is focused on the common form of healthcare with a premium, deductible, and out of pocket maximum. It was not specifically designed for other forms of health insurance like tricare for veterans or healthshare plans.
Taxes. There are no taxes in the calculation so you may want to use an after tax nominal return on investment number.
Policy changes to traditional health insurance or medicare. These effects include changes to legislation that could impact premium subsidization, included coverage, eligibility age, or any shifts towards universal health coverage.
About the Team and Author
Article Author: Ryan Connell worked for 15 years as a systems engineer identifying the heart of complex problems and leading teams to solve them. He left his engineering career in 2022 to start living more deliberately and find a new path in life thanks to FIRE (Financial Independence/Retire Early).
Site Author: Lynn Frair is a healthcare expert and personal finance enthusiast, nurse and accidental entrepreneur, who started investing her baby-sitting money at age 12. After a brain tumor in her 20s wiped out her savings, she re-built up her investments and retired at age 40. Her brain tumor experience ignited a passion about understanding and sharing what she has learned about healthcare so that others can see the possibility in their own life. She is the site owner of fihealthcare.com and also thefinanciallysavvynurse.com
Calculator Creator: Erin Osterfeld is a former software engineer who left the corporate world for a life of adventure and entrepreneurship once she reached CoastFI. She has unlocked secrets to earning passive income, now gleefully traveling many months a year. She also enjoys teaching FI principles to anyone who will listen in hopes more people take the leap to living richer and fuller lives.
Formula Contributors:
Stephen Baughier, Accountant, Founder of CampFI
Kevin Carter, Software Engineer
Erin Genz, Early-Retired Systems Engineer
Sam Ferguson, Professional Mathematician
Keith Nugent, Early-Retired VP of Software Training
Joe Olson, Early-Retired Teacher
Ralph Stikeleather, Math Specialist
Jason Yamnitz, Technical Product Manager
Author’s note: While we are happy for the calculator and original formula to be out in the public to reach a greater number of people, please do attribute credit to FI Healthcare when you do.