Managing Healthcare Costs in Retirement

Healthcare spending can account for a significant share of your retirement budget. According to research by the Employee Benefit Research Institute, a 65-year-old couple could need as much as $383,000 in savings to have a 90% chance of covering their health care expenses—including premiums, deductibles, prescriptions, and out-of-pocket costs—in retirement. The amount of retirement income that you need to budget for health care depends mainly on your age and overall health. Estimating healthcare costs and creating a strategy for spending can help reduce the amount of your retirement assets spent on healthcare.

Fitting Healthcare Costs into Your Retirement Budget

Healthcare costs are generally incurred over time and can be viewed as an ongoing regular budget item instead of a lump sum needed at the start of retirement. Health insurance premiums typically paid monthly account for between 70% and 81% of retirees’ annual healthcare expenses.

Sources of funds to help cover insurance premiums and other healthcare costs in retirement include Social Security income, Medicare, contributions to a Health Savings Account (HSA) before you retire, and long-term care insurance. Let’s look at these sources and how they fit into a budgeting process to help manage healthcare costs in retirement.

Medicare Coverage

Filing for Medicare

Compare the premiums and out-of-pocket costs of different Medicare coverage options. Include prescription drug plans in the comparison and choose the option that best suits you. Calculate your monthly premiums based on the type of coverage you select and budget for that amount from your monthly income. Remember to include deductibles, premiums, and other out-of-pocket costs. Keep enough liquid cash to meet your estimated out-of-pocket expenses for the year, if possible.

Remember that Original Medicare plans also referred to as Parts A and B, don’t cover dental and vision care, but Medicare Advantage plans typically do. Private insurers approved by Medicare offer Medicare Advantage plans. These plans generally cover the same costs as Medicare and provide the Part D prescription drug benefit. Depending on the insurer and what the policy covers, you could pay less for a Medicare Advantage plan than Original Medicare. Some plans may also extend coverage to include vision, dental, and hearing costs.

Enroll in Medicare at the Right Time

Most people preparing for retirement know that Medicare becomes available at age 65 but may not realize there is a permanent penalty for missing the initial enrollment period (IEP). Your IEP is seven months, including the three months before, the month of, and the three months following your 65th birthday. If you fail to apply during your IEP for Medicare Part B—which covers most everyday (outpatient) medical expenses—your monthly Part B premiums could increase 10% for every 12-month period you go without coverage. There’s also a 1% penalty per month for each month you delay enrolling in Part D prescription drug coverage.

Medicare coverage can be affected if you or your spouse is still working and enrolled in an employer’s health care plan. Once you enroll in Medicare, you can no longer contribute to an HSA, so if you plan to stay with your group health insurance and to keep contributing to an HSA after age 65, you may want to postpone enrolling in Part A. You may be able to delay signing up for Part B without penalty until your workplace coverage ends. Remember that once you or your spouse no longer has employer-sponsored health insurance, you’ll have eight months to sign up for Medicare during a special enrollment period (SEP) to avoid penalties.

Reduce Your Modified Adjusted Gross Income

Medicare premiums are also affected by your modified adjusted gross income (MAGI). Relatively higher-earning retirees may be subject to Medicare’s Income-Related Monthly Adjustment Amount (IRMAA), which is a surcharge on the monthly premiums for Parts B and D. The differences in premiums for Part B can be steep, so taking steps to reduce your MAGI could lower your medical costs as well. If most of your retirement savings are in tax-deferred accounts subject to taxable required minimum distributions (RMDs), which will increase your MAGI when taken, consider converting some of those funds to a Roth IRA. Roth IRAs are not subject to RMDs, which can help you manage your MAGI in retirement.

Filling in the Medicare Gap

There are several ways to create a safety net for healthcare spending in retirement.

Health Savings Account (HSA)

If you’re not enrolled in Medicare, you can save money for retirement healthcare costs with a health savings account (HSA) if you are covered by a high-deductible health plan (HDHP). Earnings grow tax-free, and withdrawals of contributions and earnings are tax and penalty-free when used for qualified healthcare expenses, including Medicare and long-term care (LTC) insurance premiums. Once you reach age 65, withdrawals from an HSA can be used for any purpose without penalty. However, ordinary income taxes will apply to funds used for nonmedical expenses.

Long-term Care Insurance

Purchasing long-term care insurance is another way to fill the gap left by Medicare. The cost of long-term care can be a significant risk to your financial situation in retirement without careful planning. A long-term care insurance policy can pay a monthly benefit toward long-term care for a specified time (usually between two and five years) or the remainder of your lifetime. Long-term care insurance can seem costly and may only be affordable for some. But with the average annual cost of a private room in a nursing home at nearly $108,405, it may be more expensive not to have it. The most cost-effective time to buy long-term care insurance is in your 50s to early 60s, and premiums may be tax-deductible if your overall medical expenses exceed 7.5% of your income.

Final Thoughts

Preparing for healthcare costs in retirement should be part of your overall financial planning strategy. We’ve just scratched the surface of ways to ensure you are prepared. At Northern Way, we’re dedicated to helping pre- and post-retirees and healthcare professionals spend their time doing what they love — like enjoying life. Contact us, and we’ll be happy to explore the possibilities to ensure you are prepared for healthcare in retirement.


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