How to Plan for Health Care Costs in Retirement

Stethoscope on top of scattered dollar bills representing the costs of healthcare.
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How do you account for health care costs in your retirement planning? If you're like most people, you're underestimating these expenses.

Although Medicare Part A, which covers some level of hospitalization, is free (assuming you worked in the U.S. long enough to qualify), the bulk of Medicare coverage is not free. You'll pay premiums for Medicare Part B, and for supplemental insurance or prescription plans. In addition, you'll have out-of-pocket costs.

When you factor all of this in, it is estimated Medicare will cover only about 50-60% of your healthcare needs. And, over time, premiums and out-of-pocket costs will go up.

Key Takeaways

  • Many retirees and people getting ready to transition out of the workforce forget to budget for healthcare when they estimate their expenses in retirement.
  • There are five types of health care premiums you are likely to have in retirement: Medicare Part B, Medigap, Medicare Part C, Medicare Part D, and long-term care.
  • Annual out-of-pocket expenses are growing along with the rising cost of medical care.
  • If you plan on retiring early (before 65) make sure you understand the cost of carrying your own health insurance premiums until you reach Medicare age. 

Don't Forget About Health Care Costs

Many retirees and people getting ready to transition out of the workforce forget to budget for healthcare when they estimate their expenses in retirement. Why? Their employer is often picking up the majority of the tab (usually about 75%) and the remaining cost (average is around 20-30%) comes out of their paycheck. They think they need the same amount of take-home pay that they currently have, but they forget that they will now be responsible for paying their health care premiums in addition to the out-of-pocket costs.

If your modified adjusted gross income (MAGI) as reported on your IRS tax return from two years ago is above a certain amount, you'll pay the standard premium amount and an Income Related Monthly Adjustment Amount (IRMAA). IRMAA is an extra charge added to your premium.

Become Familiar With Health Care Premiums

There are five types of health care premiums you are likely to have in retirement:

  • Medicare Part B: This goes up as your income goes up. In 2022, you'll pay $170.10 per month if you made $91,000 or less in 2021. If you made more, you'll pay more depending on how much you earned.
  • Medigap (Medicare Supplemental Insurance) or Medicare: If you want insurance for costs that are not covered by basic Medicare you'll look at buying either a Medigap policy or a Medicare Advantage Plan, as well as prescription drug coverage. If you have a Medigap policy, it may not cover costs for dental, vision, and eye care. There is potential for you to be left with some large expenses, particularly for dental needs.
  • Advantage Premiums (Medicare Part C): Medicare Advantage policies include Parts A and B; most also include Part D (for prescription drugs) and options for dental, hearing, and eye care. Medicare Advantage may not provide adequate additional hospitalization coverage for extended stays or a recurring condition. There is potential to leave you and your family with a large bill should a chronic or severe illness come along.
  • Medicare Part D coverage (Prescription Drug Coverage): This includes prescription drugs for self-administration. Drugs administered by a professional like a nurse or physician will usually fall under Medicare Part B coverage. Those covered with Part D coverage will pay a co-pay per prescription. Also, some drugs are excluded from coverage.
  • Long-term care insurance premiums: Medicare does not cover the majority of long-term care costs you might experience. If you want to be assured you have funds to cover these costs, consider long-term care insurance

So how much would coverage and the associated out-of-pocket costs add up to on average?

Know Your Total Health Care Costs

Multiple studies have indicated that total health care costs for Medicare beneficiaries are high. A Kaiser Family Foundation study found that the average Medicare beneficiary's annual out-of-pocket costs were $5,460 in 2016 (about $6,250 adjusted for inflation in 2021). An AARP Public Policy Institute study found that the average Medicare recipient spent $5,801 for insurance premiums and medical services on average in 2017 (about $6,500 adjusted for inflation).

This information indicates that the average Medicare recipient would need to budget almost $7,000 for out-of-pocket health care costs in 2022. An average-income married couple will need to have over $1,100 saved or accessible per month—just for healthcare—to keep from draining their retirement accounts quickly.

It's also likely that these healthcare costs will increase. The Kaiser Family Foundation projected that annual out-of-pocket expenses for Medicare beneficiaries ages 65 and over would increase between $2,000 and $4,400 by 2030 compared with 2013 (not adjusted for inflation), which means that you'll need to have even more set aside when you account for rising healthcare costs and inflation.

Visit Your Doctor Regularly

Many physicians encourage patients to lead a healthy lifestyle to avoid the burden of mounting medical bills. Take charge of your medical care and make sure you visit your doctor regularly. If the doctor can identify any health issues early, they can prescribe treatments that can reduce your expenses in the long run. It also helps to do your research and ask your doctor questions.

You might also want to have a good dentist and see them every six months to ensure your teeth and mouth are in good health and cared for.

Manage Distributions Tax-efficiently

High-income taxpayers pay more for their Medicare Part B and Medicare Part D premiums. If you make more than $91,000, you might consider working with a good tax or retirement planner to manage your distributions in a more tax-efficient way. This could help you reduce your Medicare premiums because it can keep your taxable income lower.

Distributions from HSA accounts, Roth IRA accounts, or from cash value life insurance policies don't count in the Medicare formula that determines the final amount of your Medicare Part B premiums. Income from a reverse mortgage doesn't count either. You can often offset deductible health care expenses with money you withdraw from traditional retirement accounts.

If you have large balances in traditional IRAs, it means you're likely to have a significant amount of required minimum distributions (RMDs) when you reach age 72. To reduce your RMDs, you may want to consider converting part of your IRA to a Roth before you reach age 65.

Don't Get Caught Off-Guard

Rising health care costs are going to be a reality. Make a line item in your budget for them. If you plan on retiring early (before 65), make sure you understand the cost of carrying a health insurance plan and paying the premiums until you reach Medicare age. 

Article Sources

  1. Centers for Medicare and Medicaid Services. "2022 Medicare Parts A & B Premiums and Deductibles/2022 Medicare Part D Income-Related Monthly Adjustment Amounts." Accessed Dec. 12, 2021.

  2. Medicare.gov. "What's Medicare Supplement Insurance (Medigap)?" Accessed Dec. 12, 2021.

  3. Medicare.gov. "How Do Medicare Advantage Plans Work?" Accessed Dec. 12, 2021.

  4. Medicare.gov. "Prescription Drugs (Outpatient)." Accessed Dec. 12, 2021.

  5. Medicare.gov. "Copayment/Coinsurance in Drug Plans." Accessed Dec. 12, 2021.

  6. Kaiser Family Foundation. "Medicare Beneficiaries Spent an Average of $5,460 Out-of-Pocket for Health Care in 2016, With Some Groups Spending Substantially More." Accessed Dec. 12, 2021.

  7. AARP Public Policy Institute. "Medicare Beneficiaries’ Out-of-Pocket Spending for Health Care," Page 1. Accessed Dec. 12, 2021.

  8. Kaiser Family Foundation. "Medicare Beneficiaries’ Out-of-Pocket Health Care Spending as a Share of Income Now and Projections for the Future," Pages 5, 21. Accessed Dec. 12, 2021.

  9. Internal Revenue Service. "Retirement Plan and IRA Required Minimum Distributions FAQs." Accessed Dec. 12, 2021.