Preparing for Healthcare Costs in Retirement

As more Americans receive their COVID-19 vaccinations, some feel they can see the light at the end of the pandemic tunnel. While getting more vaccines to more people is great, we are still dealing with the fiscal fallout caused by record job loss, unemployment, and multiple stimulus packages.

The pandemic forced numerous businesses to shut their doors in 2020. This not only created an immediate economic slowdown at home, but it also caused massive supply chain issues and bottlenecks worldwide. Yet another potential byproduct of the disruption may be a rapid rise in inflation in the near future.

Inflation fears impact almost all sectors, including healthcare. A 65-year-old couple entering the Medicare system in 2019 dealt with inflation of medical costs around 4.22%. That’s already significant; should predictions of an even higher spike in inflation come true, it will be more important than ever to guard your retirement nest egg against rising healthcare costs.

Retirement Healthcare Pitfalls

Even in periods where we’re not dealing with pandemics, inflation is a major concern when planning for healthcare costs in retirement. A retiree can expect the healthcare inflation rate to grow twice as much as the general inflation rate.

The impact of hyperinflation can place significant pressure on retirees whose income is mainly derived from fixed sources.

With this threat, they can expect to see medical expenses consume a more significant portion of their household budgets every year.

Another issue is life expectancy. With the enhancements of modern medicine, people are living longer. Your longevity impacts your total lifetime healthcare costs, the potential need for long-term care, and other areas of personal finances.

Despite knowing that retirement healthcare has evolved over time, the notion that Medicare will “pretty much cover everything” still exists — so much so that many future retirees have little insight into actual costs, especially in terms of long-term care. Proper planning can help account for rising costs well ahead of time, and allow retirees to avoid major surprises.

Smart planning moves could include purchasing a supplemental insurance policy, like Medigap, and budgeting for out-of-pocket medical costs. Additional out-of-pocket medical expenses will include things such as deductibles and copays, as well as other costs associated with hearing, vision, podiatry, and dental care.

Navigating the Medicare System

The Medicare Modernization Act of 2003 contained legislation that can increase your monthly Medicare cost based on your income. This is known as the income-related monthly adjustment amount.

The higher your income in retirement, the more you will pay for Medicare. Medicare means-testing surcharges can increase Medicare Parts B and D premiums anywhere from 20% to over 100%. Based on the 2021 IRS guidelines, they are triggered when modified adjusted gross income (MAGI) in retirement exceeds $88,000 for individuals and $176,000 for couples.

Medicare means-testing also has a two-year lookback provision, so income thresholds in any given year are measured against household income from the two years ago.

Remember that “income” is not just what you earn from a job; in retirement, it could be realized capital gains from investment account withdrawals or even capital gains from the sale of a home even if it took place two years ago.

This underscores the importance of planning far ahead, and being proactive around Medicare considerations. Retirees should carefully manage taxable income because it could create unnecessary exposure to Medicare means-testing surcharges.

Retirement Healthcare Solutions

A Health Savings Account (HSA) is a great tool to help you prepare for the cost of healthcare in retirement. You can open and fund an HSA if you use a high-deductible health plan (HDHP).

The tax benefits of HSAs can make potentially paying a higher deductible on your health insurance worthwhile. Money contributed to an HSA avoids payroll and Social Security taxes. If the funds are invested, investment growth is tax-free. Withdrawals are tax-free, too, as long as they are used for qualified medical expenses.

Unlike the MAGI issues discussed prior, withdrawals from an HSA account do not count towards your MAGI and do not increase Medicare means-testing exposure.

Contributing to a Roth 401(k) can also help lower Medicare means-testing exposure as well via tax-free withdrawals in retirement. Although variables such as current and future tax rates must be considered when deciding between contributing to the Roth or traditional portion of your plan if you have the option, you also need to look at factors like future healthcare costs to determine the best course of action.

When it comes to planning for retirement, we often focus on not running out of money or protecting our assets from unexpected liability risks. But as Americans live longer and healthcare costs continue to rise, we need it to make it a point not to ignore this cost in retirement.

Having a financial planner that has the knowledge and expertise to manage your retirement nest egg while preparing for medical expenses in retirement can make all the difference.

Here at Felton & Peel, we want to assist you in protecting your wealth from health care costs so that you do not put your retirement savings at risk. Give us a call today to get started.

Malik S. Lee, CFP®, CAP®, APMA®
Malik Lee is the Managing Principal of Felton & Peel Wealth Management. A CERTIFIED FINANCIAL PLANNER™ with more than 15 years of financial services experience, he is a Guest Lecturer at Morehouse College, serves on the CFP Board Council of Examinations, and is a Board Member for the FPA of GA.
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