How to Plan for Health Care Costs in Retirement

Stethoscope checks the pace of rising retirement health care costs.
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How do you account for health care costs in your retirement planning? If you're like most, you are 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 percent of your healthcare needs. And, over time, premiums and out-of-pocket costs will go up.

How People Forget About Health Care Costs in Their Budget

Many upcoming 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 percent) and the remaining cost (average is about 25 percent) 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.

What Types of Health Care Premiums Will You Have?

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

  • Medicare Part B premiums
  • Medigap (referred to as Medicare Supplemental Insurance) or Medicare Advantage Premiums (referred to as Medicare Part C)
  • Medicare Part D coverage (drug coverage)
  • Long-term Care insurance premiums

Below are details on each of these items:

  • Medicare Part B: This goes up as your income goes up. In 2018, if you made under $85,000, you would pay $134 per month. If you made more, you would pay more.
  • 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, potentially leaving you with some big expenses, particularly for dental needs.
  • If you have a Medicare Advantage policy which includes dental, vision and eye care, it may not provide as much additional hospitalization coverage, potentially leaving you and your family with a big bill should a chronic or severe illness comes along.
  • 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 might such coverage and the associated out-of-pocket costs add up to?

What Amount of Total Health Care Costs Might You Experience?

For an estimate of your own current and future health care costs try the online health care cost calculator by HVS Financial.

For a male, age 65, and the calculator estimated total premiums and out-of-pocket costs at about $4,500 a year. That means if you haven't put about $375 a month into your budget for health care costs, you're going to find yourself short on cash. It's also likely that these healthcare costs will rise at about double the rate of inflation, which means 10 years into retirement that $375 a month may be closer to $675 a month (using a 6 percent inflation rate).

For a married couple, you need to double those numbers. Ouch.

What Can You Do to Reduce Rising Health Care Costs?

We recently spoke to Dan McGrath, formerly with HealthView Services, and he offered three suggestions to help control rising health care costs. 

Stay Healthy

Who wants a long, unhealthy life? Take charge of your medical care. Do research. Ask questions.

Dan had some intriguing comments on staying healthy. Two that stuck with us:

Manage Distributions Tax-Efficiently

Dan also had many thoughtful comments about managing account distributions in a tax efficient manner.

For high-income taxpayers (for 2018 that means singles with expected income of $85k or more, marrieds at $170k or more), the more you make, the higher your Medicare Part B premiums and the higher your Medicare Part D premiums. If you work with a good tax planner or retirement planner you can use the following ideas to manage distributions more tax efficiently, and potentially keep your premiums from rising as much:

  • Distributions from HSA accounts, Roth IRA accounts or from cash value life insurance policies don't count in the formula that determines the final amount of your Medicare Part B premiums. Income from a reverse mortgage doesn't count either.
  • Money withdrawn from traditional retirement accounts can often be offset with deductible health care expenses.
  • Since Roth IRA withdrawals don't count in the formula that may increase your Medicare Part B premiums, if you have large balances in traditional IRAs that means you will have a significant amount of required minimum distributions at age 70 and beyond, and you may want to consider converting part of your IRA to a Roth before you reach age 65. In particular, Dan said, "the Roth is the greatest investment vehicle known to people". We agree with him.

    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 your own health insurance premiums until you reach Medicare age.