Taming the High Cost of Health Care During Retirement

I recently met with a client to review their investment accounts and financial plan. During the course of our meeting the topic of aging came up. As we talked about getting older and the challenges that aging presents, I remembered something an old client had told me at the very beginning of my financial planning career. Tom and his wife Mary were clients during my years at the brokerage firm. Tom was in his early seventies, but was afflicted with Parkinson’s disease. During one of our first meetings, Tom looked straight across the table from me and deadpanned, “Let me tell you something Phil, getting older isn’t for sissies.”

Tom was right, “Getting older isn’t for sissies.” Aging presents many challenges, and most of them are physical or health-related. But aging also poses financial challenges to retirees. Recent research from Fidelity Investments indicates that a couple who retired in 2015 can expect to spend an estimated $245,000 for healthcare during their retirement. But healthcare costs are only half of the story.

According to the Social Security Administration, Social Security provides an annual income benefit of $26,500 for the average retired couple.  And the average retirement nest egg for Americans age 50 and over is only $135,000 according to information produced by Transamerica in December of 2015. Data from the Economic Policy Institute published in March of 2016 is slightly more encouraging, showing the average retirement savings of couples aged 56 to 61 was $163,577 in 2013. But the danger is clear: healthcare costs threaten to consume the majority, if not all, of the average retired couple’s retirement income and savings. And with healthcare costs experiencing an average inflationary rate of 7% or more, the situation is only likely to get worse.

If you aren’t too discouraged by this information, please read on, because there are some things that you can do (especially if you haven’t reached retirement age yet) to lessen the sting of healthcare costs.

One of the easiest ways to save for future healthcare costs is through a health savings account (HSA). HSAs are relatively new healthcare savings vehicles, coming into existence in December of 2003 under President George W. Bush. Health Savings accounts are available to many participants who are enrolled in high deductible healthcare plans. The real beauty of the health savings account is that it is triple-tax advantaged. Tax advantage one is that contributions can be made on a pre-tax or tax-deductible basis. Tax advantage two is the tax-free growth while the funds remain in the health savings account.  And finally, when used for qualified medical expenses, withdrawals are tax-free too (more about this in a moment).

A significant way to reduce healthcare costs is by reducing Medicare insurance premiums. Medicare provides health insurance for Americans age 65 and older as well as some younger Americans with certain disabilities. What many pre-retirees don’t realize is that Medicare premiums are based upon retirement income, particularly modified adjusted gross income (MAGI). At the recent Retirement Income Summit in Chicago, presenter Peter Stahl, CFP® estimated that a married couple who are able to move down one income threshold level (as measured for Medicare purposes) could save themselves $65,000 in Medicare premiums over a twenty year period.

$65,000 is a pretty sizable piece of the lifetime $245,000 in healthcare expenditures that Fidelity estimates, so reducing the amount spent on Medicare premiums is worth pursuing for most retirees. What are some of the strategies that retirees can pursue to lower their Medicare premiums?

Drawing down non-qualified retirement savings for income needs, instead of drawing from traditional IRA or 401(k) type investment accounts will reduce your taxable income and can push you into a lower Medicare income threshold level. This means you should not have all of your retirement nest egg in investment vehicles that are taxed as ordinary income upon withdrawal. Roth IRAs and regular investment accounts provide tax-free withdrawals for retirement income needs. Non-qualified annuities provide both taxable and non-taxable income upon withdrawal and can potentially lower your tax liability and push you into a lower Medicare premium threshold. The best option of the three by far is the Roth IRA, so if you have not yet started funding a Roth IRA or have low Roth IRA balances make building up your Roth IRAs a priority.

Tapping HSAs for healthcare expenditures is another way to get access to tax-free withdrawals. Just remember that the withdrawals must be made for medical expenses to qualify for the tax-free treatment.

Permanent life insurance policies can be another source of tax-free money. Withdrawals and policy loans from the cash value of the life insurance policy are generally tax free (with a few exceptions) and can help take retirees below a Medicare threshold level and reduce the insurance premiums paid.

Reverse mortgages are another option for some retirees. Although there are many complications and reasons to be cautious about using reverse mortgages, for some retirees they may be viable strategies to provide tax-free retirement income.

We may not have a lot of control over growing older or the health care concerns associated with aging. A lot of that depends on genetics, exercise, diet, lifestyle and just plain dumb luck. But we may have some control over the cost of healthcare as we get older. If you are near the age of qualifying for Medicare, or are already age 65 or older you may be able to reduce your healthcare expenditures. Be sure to schedule an appointment with us to ensure that you are doing everything you can to minimize the financial challenges of growing older.

Sources:  InvestmentNews, Social Security Administration, Economic Policy Institute, Transamerica, Fidelity Investments