Most people get the basics right when it comes to retirement planning. There’s housing, food, transportation, and travel—the obvious things that are easy to plan for since they’re already in your budget. What trips people up, however, is saving for the cost of health care in retirement...
The following is a guest post by Danielle Kunkle. Danielle writes regularly for many online publications, including Forbes, where she is a member of the Finance Council. A TCU journalism graduate and former magazine editor, she enjoys sharing her knowledge, find more of her articles on daniellekroberts.com.
Most people get the basics right when it comes to retirement planning. There’s housing, food, transportation, and travel—the obvious things that are easy to plan for since they’re already in your budget.
What trips people up, however, is the cost of health care once you retire. If you’re like most people, you’re covered by a group health plan and your premiums are heavily subsidized by your employer. There’s an out-of-pocket maximum each year, so you know you won’t be financially devastated by a serious illness or injury. Generally speaking, your costs are fairly predictable.
Unfortunately, predictability is definitely not a feature of health care costs in retirement. That’s why it’s important to prepare yourself now, so health spending doesn’t wipe out your retirement budget.
Health spending in retirement
Fidelity research shows that a couple retiring at age 66 today will spend nearly $300,000 out-of-pocket on health care costs in retirement, assuming a 25-year life expectancy.
What goes into that figure? First, there are Medicare premiums. Unlike your employer plan where premiums are paid in part by the company, you’re on the hook for the entire cost of your Medicare premiums. As of 2019, the Part B premium is $135.50; historically, it goes up every year.
If you enroll in a Part D prescription drug plan, there’s a separate premium for that. Most people who choose Original Medicare (Part A and Part B) for their coverage also buy a Medicare Supplement Plan, which means yet another monthly premium. Those who choose Medicare Advantage still pay the Part B premium, plus any premiums charged by your plan.
You also have deductibles, coinsurance, and copayments with Medicare; Part B only pays 80% of allowable charges. Medicare Advantage plans typically use a copayment cost-sharing structure; they may or may not have an annual deductible.
There are also health expenses Original Medicare doesn’t cover. Most seniors continue their twice-a-year routine dental visits and annual eye exams in retirement; none of those services are covered by Medicare. If you sign up for Medicare Advantage, however, your plan may cover dental and vision care.
The National Institutes of Health says that nearly 40% of women over age 65 and nearly 20% of men take four or more daily prescription medications. All Part D prescription drug plans collect a copayment for your medications, and some also charge an annual deductible.
Finally, your risk for many serious diseases and conditions increases rapidly as you age. Your expenses as a relatively healthy working-age person are naturally a lot less than those of seniors. Per capita health care spending on seniors is more than double that of people under age 65. Over 70% of people retiring this year will need long-term care; the average length of stay is over two years. It’s no wonder health care spending is so high in retirement.
Saving for retirement health care costs
It’s extremely hard to predict your health care costs in retirement, which is why it’s so important to separate your health savings from your retirement savings. Just one year of catastrophic health expenses drawn against your retirement account could wreak havoc on your income and planned withdrawals for years.
That’s one of the reasons health savings accounts were created in the Medicare Modernization Act of 2004. HSAs are special tax-advantaged accounts that let you contribute pretax dollars into an investment account where it grows tax-free indefinitely. Most HSAs let you invest your money in mutual funds, index funds, ETFs, individual stocks, and bonds, so it grows faster than tucking it away in a savings account.
Even better—you don’t pay income tax on HSA withdrawals for qualified health expenses. As a bonus, once you turn 65, you can use the money in the account for anything and still owe no income tax.
Prior to retirement, you can use your HSA money for deductibles, coinsurance, copayments, and even some over-the-counter drugs and medical devices. Premiums aren’t considered qualified medical expenses.
After retirement, however, the money can be used for anything—including your Medicare, Medigap, and Part D prescription drug plan premiums. You can even withdraw the money for non-medical expenses tax-free.
The current contribution limits are $3,500 for individuals and $7,000 for families, once you turn 55, you can contribute an extra $1,000 a year. Unused contributions roll over indefinitely. Once you enroll in Medicare, however, you can no longer add to your HSA.
Opening an HSA is one of the best ways to save for health care costs in retirement. You have a stash of cash you can use to offset your medical bills now and help pay your Medicare premiums and out-of-pocket costs in retirement without ever touching your IRA or 401(k) savings.
To Wrap it Up
No one can put a precise dollar amount on his or her cost of health care in retirement. One thing everyone can do is do more to prepare for it. By knowing what savings vehicles will provide the most value for your savings, you can set yourself up for long-term success.
Just as you budget and plan for the daily and reoccurring necessities in your life, take the time to plan and budget for the costs of health care in retirement.
