Healthcare costs are an important factor to consider when creating your retirement income plan. You want to ensure that these expenses are properly accounted for. However, these costs can potentially be affected by your income in retirement.
Some higher-income retirees may have to pay more for their Medicare Part B and Medicare Part D prescription drug coverage. This is due to something called the Income-Related Monthly Adjustment Amount (IRMAA).
The Income-Related Monthly Adjustment Amount (IRMAA) is an amount you may pay in addition to your Medicare Part B or Part D premium if your income is above a certain level. The income used to determine IRMAA is a form of Modified Adjusted Gross Income (MAGI).
It is different from your Adjusted Gross Income because it includes tax-exempt interest income. The 2021 annual modified adjusted gross income thresholds are $88,000 for single filers and $176,000 for joint filers.
If your income falls above these thresholds in a given year, you are subject to the additional IRMMA surcharge in two years. For example, this year’s IRMAA surcharges are based on 2019 federal tax returns.
(MAGI) = Adjusted gross income + Tax-exempt interest income
For those with income above the annual thresholds, the Part B premium ranges from $207.90 to $504.90. The Part D premium ranges from $12.30 to $77.10 in addition to your plan premium. The chart below shows the costs of the monthly premiums per individual.
For example, a married couple (filing jointly) has $5,000 interest income, $20,000 dividend income, and $5,000 tax-free interest; $105,000 of IRA income; and $50,000 annual Social Security benefits (of which only 85 percent, or $42,500, is considered taxable in the formula for modified adjusted gross income) for a total annual income of $185,000.
Their resulting modified adjusted gross income is $177,500, which is over the $176,000 income threshold for joint filers, and they could be subject to increased Part B and Part D premiums in two years*.
Based on the 2021 figures, this would increase their Part B premium by $59.40 per month, and their Part D premium by $12.30. This would result in a total premium increase of $860.40 per spouse for that year.
This could be done by reducing your modified adjusted gross income. One way to do this is by replacing some of your traditional IRA income with tax-free Roth IRA income.
Going back to the previous example we can illustrate how the use of a Roth IRA may help reduce (and possibly avoid) the IRMAA surcharges on Medicare insurance premiums. In this new scenario, the couple has reduced their traditional IRA income to $100,000 and added $5,000 tax-free income from a Roth IRA.
As a result, they would not be subject to the premium surcharges in two years. Their Roth IRA income is excluded from the MAGI formula, and thus their income is only $172,500, which is below the $176,000 threshold for IRMAA*.
Understanding how IRMAA surcharges can potentially increase your healthcare costs in retirement allows you to explore strategies to manage your income in retirement. Depending on your mix of tax-deferred, tax-free, and taxable assets, you may have the flexibility to control your income in a given year.
The sooner you can create your retirement income plan, the greater the potential options you will have available to you.
*These hypothetical examples are used for illustrative purposes only. Actual results will vary.
The art of good decision making is looking forward to and celebrating the tradeoffs, not pretending they don’t exist
Specificity in Training
When training you tend to have a specific goal in mind, meaning if your focus is on getting stronger, you should prioritize your exercise activities on specific movements with a set training volume and intensity to drive the stimulus required to get the desired results. The more specialized the training, the more you can optimize the results.
Any training you do that does not have the specific intent to improve the desired outcome will lead to sub-optimal results.
For example, if someone wants to perform their best at a powerlifting meet they will likely have to train differently than someone who wants to run a good time in a 5k race. This does not mean the person who does powerlifting can’t do distance running, or vice versa but compromises will need to be made to their relative performance in either event.
If someone wants to maximize their potential in one arena it will be at the detriment of the other. This means as your goals change, you will likely have to modify your training accordingly to produce the greatest results.
Specificity in Investing
Similar parallels can be drawn to investing. The characteristics of different types of investments lend to their effectiveness based on the objectives of the investment strategy someone put in place. The three characteristics I will discuss today are growth, income, and stability.
Growth: Becomes more valuable over time. (Buy at X, sell at Y)
Investments that offer the greatest potential of growth, will likely not provide much stability or income.
Income: Receive payments of dividends or interest.
Investments that produce a large amount of income may not offer the greatest stability or potential for growth.
Stability: Preservation of your initial investment.
Investments that offer a high level of stability probably do so at the cost of the possibility of growth or income generation.
A diversified portfolio will have a blend of assets with differing characteristics
You will likely have portions of your portfolio focused on either growth, income, or stability. How much you allocate to each of these assets will determine how your overall portfolio will perform. Therefore, your investment strategy should be based on what is important to you and created to give you the greatest chance of reaching your desire outcome.
Investing With a Purpose
Just like with training there is a give and take between optimizing for growth, income, and stability. It is not possible for a single investment to have all of the good qualities of each and none of the bad. As your priorities shift from one area to another you may likely have to reconsider how you are invested and find a new balance to align your investments with what you want to do for yourself.
Often this means making compromises in your overall returns or your overall comfort level. Having a portfolio allocation you can stick with both in good times and in bad is a critical factor in your long-term success as an investor.
In training and investing, we are dealing with limited resources and have to find balance and make compromises as a means of achieving our set objective. As our objectives change we will likely have to make adjustments to find a new optimum for our given circumstances. Being able to continually iterate and make the most of what you have is a key component to success in any endeavor.
Medicare is the federal health insurance program that covers most people who are age 65 and older. It is composed of different parts that help cover specific services.
Original Medicare is divided into hospital insurance (Part A) and medical insurance (Part B), which are run by the federal government. Medicare Part C (Medicare Advantage) and Part D (prescription drug coverage) are provided by private insurance companies approved by Medicare.
Below is a basic breakdown of the Medicare coverage options someone has available to them at age 65.
Coordinating Medicare Benefits When Working Past 65
Use Your Employee Benefits Manager as a Resource
We are often asked how to enroll in Medicare when someone is over 65 and wants to retire from their current employer. We often guide them to their employee benefits manager to determine whether they have a group health plan coverage (as defined by the IRS) and to see what portions of Medicare (if any) they are already enrolled in.
Individuals with group health coverage based on current employment may be able to delay Part A and Part B and won’t have to pay a lifetime late enrollment penalty if they enroll later.
Medicare Part A Eligibility
If they are eligible for premium-free Part A, they can enroll in Part A at any time after they are first eligible for Medicare. Their Part A coverage will go back (retroactively) 6 months from when they signed up (but no earlier than the first month they were eligible for Medicare).
If they were eligible for premium-free Part A, and they didn’t buy it when they first eligible, they may have to pay a penalty. They may be able to sign up for Medicare during what is called a “Special Enrollment Period” (SEP).
This is available to them anytime as long as they or their spouse are working and covered under a group health plan from your current employer.
Coordinating Medicare Benefits When Retiring After 65
If they are not enrolled in Part A and/or Part B. There is an 8-month SEP to sign up for Part A and/or Part B that starts (whichever happens first): The month after the employment ends or the month after group health plan insurance based on current employment ends. There usually is not a late enrollment penalty if you sign up during a SEP.
COBRA Coverage and Medicare
You may be able to get COBRA coverage, which continues your health insurance through the employer’s plan (in most cases for only 18 months.) Don’t wait until COBRA ends to enroll in Part B. If you don’t enroll in Part B during the 8 months after the employment ends you may have to pay a penalty for as long as they have Part B and you won’t be able to enroll until January 1–March 31 and have to wait until July 1 of that year before your coverage begins. This may cause a gap in health care coverage.
High-Deductible Health Plans and Medicare
Under IRS rules cannot contribute to an HSA any month when you are enrolled in any part of Medicare (Part A, B, or D). If your current employer coverage is a high-deductible health care plan you may want to consider enrolling in Medicare until you retire.
To avoid a tax penalty, they should stop contributing to your HSA at least 6 months before they apply for Medicare. Part A coverage will go back (retroactively) 6 months from when they sign up (but no earlier than the first month they are eligible for Medicare).
Keep Your Notice of Credible Coverage
If they are not enrolled in Part D. There is also a 2-month SEP after the month your coverage ends to sign up for a Part D Medicare Prescription Drug Plan.
If you decide to join a Medicare drug plan, you should the “Notice of Credible Coverage” you receive. You will get a “Notice of Credible Coverage” each year if you have drug coverage from an employer/union or other group health plan. This notice will let you know if your current drug coverage is “creditable.” Keep this notice.
Start By Understanding Your Current Coverage
Medicare is complex and there are many decisions one must make when choosing your healthcare coverage. If you are over 65 and still employed it is important to first understand when the coverage you currently have through your employer, which (if any) part of Medicare you are already enrolled in.
From there, you will have a better idea of what the next steps need to be taken, to avoid any penalties and more importantly make sure you have proper coverage.
If you retire before the age of 65, be that a planned retirement or something else, you will not be eligible to begin Medicare benefits and need to bridge the gap between the time when you retire and that date. Depending on your circumstances you could see a significant increase in healthcare costs during this period. With this in mind, it would be prudent to plan for an increase in annual premiums and additional out-of-pocket costs after your employer-subsidized group health insurance ends.
Healthcare Options Between Retirement and Medicare
The Consolidated Omnibus Budget Reconciliation Act of 1985, COBRA, is available to former employees of employers with 20 or more full-time employees. You will typically pay the full cost of coverage plus a 2% administrative cost. This can result in premiums being 3 to 5 times higher than they were when they were an employee since the cost of coverage is no longer subsidized by the employer.
Since COBRA is continuing the same coverage you had as an employee, you keep your existing network of doctors and have the same copayments, coinsurance, and other plan features. You must sign up for COBRA within 60 days of when you are notified then, you can make the election, and coverage typically lasts for up to 18 months after your separation from employment.
*One special note is if you are on your spouse’s employer plan and they enroll in Medicare you may be able to continue your coverage under COBRA for up to 36 months.
Coverage through a spouse’s plan
When you retire and were currently covered under your spouse’s employer health insurance plan, you will likely be able to continue your coverage as long as they continue to work.
This could be your least expensive option if it is available to you and like with the COBRA option there should be no change or disruption in your coverage. This option would likely only be available as long as your spouse continues to work.
The Affordable Care Act established a public marketplace and provides coverage options to anyone who is not eligible for Medicare yet. The plans are categorized by metal level with “Bronze” being the least expensive and “Platinum” the most. Bronze plans typically have lower premiums and higher deductibles, while Platinum plans have the highest premiums but the most comprehensive coverage. Silver and Gold plans fall in between these two plans.
Open enrollment is from November 1 to December 15 each year for the www.HealthCare.gov marketplace. However, there is a special enrollment period for individuals who had “certain life events” such as losing health coverage. The special enrollment period can vary based on the specific life event.
You could be eligible for Advance Premium Tax Credits (APTC) if you purchase a policy on the exchange and your household income falls between 100% and 400% of the federal poverty level. In most states, you can qualify for a subsidy for a plan in 2021 with an income as much as $51,040 for a single person household, $68,960 for a two-person household, and $104,800 for a 4 person household. *Note these maximums are higher in Hawaii and Alaska.
You can go to www.healthcare.gov to see the coverage available to you in your state and if you may be eligible for federal premium tax credits.
You can also obtain coverage through a local insurance agent who offers plans from multiple carriers through the “private exchanges.” Since these exchanges are not government funded, the Advance Premium Tax Credits cannot be applied but do provide more plan options. You can find a health insurance agent or broker at www.nahu.org to help navigate you through the individual market.
Planning for Pre-Medicare Expenses
People are often surprised by the cost of health insurance between the time of employment and Medicare eligibility. That is because their employer often subsidizes a portion of their health insurance, so when they see the price of COBRA coverage or coverage on the public exchange, there can be a sticker shock.
The graph below comes from a 2018 study by Vanguard/Mercer where they estimated that the median cost of a Bronze plan on the exchange for a pre-Medicare 64-year-old, and compared that to the average employer-sponsored plan for the same age group and the cost of Medicare coverage would be for someone age 65 and eligible for Medicare.
They also layered the out-of-pocket costs for their estimates for “medium” and “high” risk individuals. As you can see there is a large difference in cost between employer-sponsored coverage, Marketplace (pre-Medicare) coverage, and Medicare.
Regardless of the type of coverage you select, you will have to consider two factors:
Out-of-pocket costs (including dental and vision)
Your insurance premiums vary based on the type of plan you select and could vary from year to year but is likely predictable once the initial coverage is established.
The other factor is out-of-pocket costs, which include deductibles, copays, coinsurance, or other services not covered by the plan. These expenses can vary greatly year to year and can depend on your current health levels, predicted future health levels, and the amount of risk you want to take on in your plan.
How Your Health Impacts Your Cost of Coverage
Your current health conditions are relatively straight forward to assess by asking:
Do you currently have significant health care out-of-pocket costs? Typically people in poor health, already have higher than average out-of-pocket costs.
If you have pre-existing or chronic conditions, do you expect these to continue indefinitely? The more chronic health conditions you have, the worse your health is projected to be.
Do you consider your health to be average or below average? Some people are overly optimistic about their current conditions, and while this is a great outlook on life when planning healthcare expenses it is more conservative to have a pessimistic lens.
Your future health level can be based on your family history of chronic disease or based on your current health conditions. Even if you don’t have any current or expect any in the future, it would be prudent to overestimate the out-of-pocket costs rather than not.
The unfortunate fact for most is you are likely the healthiest you will ever be right now and will see a gradual decline as you age.
How to Plan for Healthcare Costs in Retirement
When planning for healthcare expenses, it is better to look at healthcare expenses as a reoccurring annual cost that may change based on the type of coverage you have. Yes, your total cost of coverage may change year to year due to unforeseen out-of-pocket expenses, but it still better to frame healthcare costs in this way. Healthcare costs also tend to increase at a rate higher than general inflation, and this should be accounted for in your planning assumptions.
Healthcare will be another line-item expense in retirement and although it will be sizable, it should not be overwhelming when planned for accordingly like every other expense in retirement. Factors such as your health, where you live, your age, and marital status should all be considered when you are making decisions on healthcare.
Planning for healthcare is highly individualized and the expected costs could vary greatly based on the type of coverage available, your age, gender, health status, and geographic location. Getting a grasp on how these factors affect your situation can help to make more reasonable assumptions when planning for retirement pre-Medicare.
One final note, planning for health expenses is distinct from planning for long-term care needs in retirement, and this separate issue needs to be considered.