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Don’t Forget Your Healthcare

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Imagine you’re planning a once in a lifetime Hawaiian vacation. You’ve established a set budget of $8,000 for arranged accommodations, meals, excursions, and a rental car when you arrive. You’re feeling confident that you have planned well, and have wisely allocated nearly your entire budget for this vacation. You even splurged on a new wardrobe with the remaining resources. 

The day finally arrives, and you’re so excited. You gather up all of your luggage, and throw them into the UBER driver’s car and head towards the airport. That’s when you realize you didn’t book any flights. YIKES!

Oh, no. What do you do now? Plane tickets will eat up at least 25% of your vacation budget. But you have already allocated the entire $8,000 for what you thought was careful planning. What will you have to give up in order to still make your Destination? Will you cut planned dining experiences, excursions, or settle for less than desired accommodations? 

Failing to account for healthcare spending in retirement can be a lot like forgetting to purchase plane tickets for your once-in-a-lifetime vacation. You can’t make it through retirement without it, and it often makes up a pretty significant portion of the overall spending plan throughout retirement. Failing to plan for healthcare expenses accordingly may leave folks forced to downgrade their desired lifestyle as a result. 

Underestimating the Impact of Healthcare Spending

The cost of healthcare in retirement is often underestimated by many folks. Those who are rapidly approaching the transition between their working years and their post working years might want to take a closer look before they leap. The cost of health insurance, co-pays, and out of pocket expenses is often a barrier to early retirement. On the other hand, those who completely ignore it all together are often shocked at the percentage of their spending dedicated to healthcare in retirement. Furthermore, many are knocked flat by the cost of health insurance when they are no longer covered by an employer sponsored plan prior to the age when they or their younger spouse are eligible for Medicare. 

Perhaps you may be wondering if you can retire before age 65, or will I need to wait until after I’m eligible for Medicare. Well, this is a great consideration to be mulling over before exiting the workforce and leaving your employer sponsored healthcare in the dust. We would applaud anyone having the foresight to think through this before making the transition.

However, there’s much to consider before making the jump. Here is a list of questions you might want to ask yourself as you plan for your future: 

  1. If I retire now, am I eligible for Medicare?
  2. If I retire and am eligible for Medicare, what happens to my younger ineligible spouse prior to age of eligibility?
  3. How much should I plan to spend on healthcare for each spouse once we’ve reached the age of Medicare eligibility?
  4. If we lose our workplace plan eligibility before Medicare eligibility age (currently 65) how much should we budget per individual spouse per month, after tax?
  5. Should we consider COBRA insurance as an option to fill the gap between employment termination and Medicare eligibility? 
  6. Where will the resources to pay premiums, co-pays, and out of pocket expenses come from? 

If I retire now, am I eligible for Medicare?

If you have reached age 65 you are eligible for Medicare. Your initial enrollment period opens 3 months prior to your birth month, includes your birth month, and the three months after your birth month. There’s a total of seven months during your initial enrollment period. 

As an example, my birth month is January. My open enrollment period would start in October the year I turn 64, and run through April of the year I turn age 65. However, If I choose to retire from a position of employment that provides employer sponsored healthcare prior to Medicare eligibility age I may need to acquire health insurance coverage to fill the gap between the date of severance, and January of the year I turn age 65. The after-tax cost of healthcare coverage prior to Medicare eligibility could come as a big surprise if you have not already planned for it. 

If I am eligible for Medicare and retire what happens to my younger ineligible spouse prior to age of eligibility

The answer in this case is – it depends. Is the employer sponsored healthcare provided by an employer your work for? Or, is it provided by an employer for whom your younger spouse works for? 

If the access to employer sponsored healthcare is tied to your employment and you terminate your position you will likely sever the access to employer sponsored healthcare for both spouses. This is most often the case, but not always. 

On the other hand, if the employer sponsored healthcare coverage is provided through your younger spouse’s employment you may be able to transition to Medicare, and your younger spouse could potential reduce the employer plan to a lower cost individual option. While it may make sense to transition off your spouse’s workplace plan to Medicare, this is not always the case. Sometimes, if you are still eligible for coverage as a spouse, it may make sense to stay on your younger spouse’s employer sponsored plan. 

How much should I plan to spend on healthcare for each spouse once we’ve reached the age of Medicare eligibility?

The total out of pocket expenses for Medicare, co-pays, and out of pocket expenses not covered by Medicare will very for each household based on income, as supplemental plans elected. 

For most folks Medicare Part A (Hospital insurance) requires no premium to be paid if you or your spouse have paid Medicare tax for a certain period of time.  However, if you don’t qualify for “premium-free” Part A because you did not pay Medicare tax for at least 30 quarters you can purchase it for a monthly premium.  

Medicare Part B premium in 2020 is approximately $144 per month per individual for a married couple filing jointly with a taxable income in 2018 of $174,000 or less (Medicare premiums are based on income from two years prior). Income exceeding $174,000 will result in a progressively higher Part B premium up to a maximum of nearly $500 per month per individual for those who have a combined income of over $750,000. This is another reason to consider tax mitigation strategies such as strategic Roth conversions, and the blending of income from taxable, after-tax, and never taxed accounts in order to manage your tax footprint in retirement. 

Since Medicare does not pay 100% of expenses associated with your healthcare in retirement, you may opt for a Medigap or Medicare Advantage plan. Both are offered through private insurance companies, and each have their advantages and disadvantages to be weighed before deciding which is right for you. 

You may also have to purchase a prescription drug plan in addition if your Medigap or Medicare Advantage plan that doesn’t include prescription drug coverage. 

When all premiums, co-pays, and out of pocket expenses are accounted for the total out of pocket expenses for a couple on an annual basis may likely exceed $10,000. When developing a spending plan with folks we serve we often recommend planning for $400-$500 per month for each spouse to cover the cost of healthcare, and then adjusted that rate of spend at a 5% inflation.  

(The internal TWFG team knows the importance of planning for healthcare expenses in retirement, but we do not claim to be experts when it comes to making specific health insurance coverage elections. Rather, we have a close association with a local independent health insurance agency that specializes in guiding folks to make decisions about healthcare insurance, Medicare elections, and to evaluate Medigap and Medicare advantage plans for each specific household.)

If we lose our workplace plan eligibility before Medicare eligibility age (currently 65) how much should we budget per individual spouse per month, after tax?

When you sever employment from an employer who is sponsoring your healthcare coverage typically you and your spouse will lose access to the employer’s group coverage. If you do this prior to Medicare eligibility age you will likely have to purchase an individual plan at a significantly greater expense. 

The premiums for an individual plan covering a single insured between the age of 60 and 65 could quickly exceed $900 to $1,000 per month. For a couple it is likely double that. They might have to plan for an after-tax expense of $24,000 per year just to cover healthcare prior to the age of Medicare of eligibility. The high cost of healthcare insurance prior to Medicare eligibility is often a deterrent for many folks to retire early. However, it doesn’t have to be with proper planning. 

What we often witness is a situation like this. The two spouses are separated by age. The first spouse reaches age 65. He decides he’s ready to retire. In doing so, he plans to switch from his workplace sponsored plan to Medicare. This may work well for him, but what about his younger spouse? 

If she is not eligible for the workplace sponsored plan of her own, and loses access to his plan due to the severance of employment, she has no coverage! In that case they might find themselves shopping for an individual plan for her. She’ll need coverage until she turns 65, and they may find themselves shelling out over $1,000 per month in insurance premiums to fill the gap until she is eligible for Medicare as well. If she’s 63, only two years younger than he is, they may need to plan on an additional $24,000 of after-tax spending in order to fill the gap. If they are using pre-tax dollars from an IRA to pay for the premiums they may need to withdrawal closer to $30,000 over that 2-year period in order to settle up with state and federal taxes due upon withdrawal. 

If they had not properly planned for this prior to him severing employment and losing healthcare coverage for her, how might this impact the longevity of their retirement assets? How might this affect their ability to maintain a desired lifestyle? 

Should we consider COBRA insurance as an option to fill the gap between employment termination and Medicare eligibility?

It may make sense for the younger spouse in the previous example to elect to stay on the same group plan offered by the former employer by electing COBRA insurance. The Consolidated Omnibus Budget Reconciliation Act (COBRA) allows folks in certain situations to pay premiums and retain the same group coverage that was accessible while employed. 

Qualified individuals can expect to pay premiums up to 102% of total coverage premiums for the plan, and the former employer doesn’t subsidize any of it. However, for some folks COBRA insurance can be a desirable strategy for gaping healthcare coverage until Medicare age eligibility is attained. It can even apply to a spouse of a former employee who has not yet attained Medicare age. 

However, COBRA is a secondary payor to Medicare. Therefore, if a former employee elects COBRA coverage prior to attaining Medicare eligibility as a short-term gap coverage, and then subsequently is eligible for Medicare, he must sign up for Medicare as soon as he is eligible. COBRA won’t cover expense as a primary payor at that point. Thinking that you have coverage only later to find out that Medicare is being billed for care as Primary when you haven’t signed up, and your COBRA plan as secondary, can be a very costly mistake. 

Seek the guidance of a healthcare insurance professional in advance of making any elections effecting your health insurance coverage options. We’ll happily guide you toward an independent insurance professional if you do not have someone to work with already. 

Where will the resources to pay premiums, co-pays, and out of pocket expenses come from?

You’ll likely have a multitude of retirement resources at your disposal to maintain your lifestyle throughout retirement. However, some may be more advantageous than others when it comes to planning for healthcare expenses. Understanding the impact of taxation on distributions from various accounts and income streams will aide in your planning efforts.    

  1. Pre-tax retirement resources: They likely make up the bulk of the retirement resources available to many folks nearing retirement. Pension income (if you are lucky enough to own it) and distributions from IRA, 401Ks and other IOUs to the IRS are taxable as ordinary income. If you plan to cover healthcare expenses with pre-tax sources be sure to gross up planned distributions for taxes. These retirement resources haven’t been taxed yet, and your future tax rates have yet to be determined. If we need $1,000 per month to cover insurance premiums, co-pays, and out of pocket expenses you may need to plan on distributions closer to $1,250 assuming a state tax of 5% and fed tax of 15%. Don’t forget inflation either. Plan to adjust for increases that exceeds most other goods and services. 
  2. Health Savings Account or HSA: Distributions from HSAs used to cover qualified healthcare expenses in retirement are tax free. Funding an HSA each year in preparation for retirement can play a significant role in the covering some of the costs associated with healthcare in retirement. It may also be an effective tax mitigation strategy as well. By the way, did you know that you can make a once in a lifetime transfer from your IRA to an HSA? It’s true. You can transfer up to the eligible HAS contribution for that year. For example, you could transfer some of your forever tax money (from a traditional IRA) into an HSA account designated for tax-free qualified healthcare distributions. Effectively you could avoid taxes on the transferred amount from your IRA. 
  3. Distributions from Roth IRAs: Roth IRAs are never taxed under currently tax law. Therefore, if you plan to cover healthcare with Roth IRA distributions you won’t have to gross up for taxes. However, few folks have saved sufficient retirement resources into Roth IRAs to cover the majority of their expenses in retirement opting instead for tax deferral in traditional IRAs or 401ks. This may make strategic Roth conversion even more beneficial to these folks. Taking advantage of lower tax rates as a result of the 2017 Tax Cuts and Jobs Act might be a good place to start. It may be possible to pay off tax obligations to the government on traditional IRAs at a significant discount through 2025.  If you think taxes are going to be higher in the future than they are today it may be time to consider strategic Roth IRA conversions.
  4. Lifetime income from an annuity: Some folks may choose to purchase a lifetime income annuity with a portion of their retirement assets to produce an income stream that will last as long as they do to help offset the cost of health insurance premiums, co-pays, and out of pocket expenses throughout retirement. An annuity is not right for everyone, but for some it may be right for a portion of their assets. It’s also possible to create a tax-free income stream for life if Roth IRA dollars are leveraged to fund the income annuity purchase. 

Plan with Purpose and Retire on Time

Often times we see folks who are ready to make that transition from their working years to their post working years. They’ve dedicated time to saving towards the future, and a few have creating a lifestyle by developing a spending plan. What is often overlooked however is the impact of healthcare expenses on their retirement resources. This is a prime example of why full comprehensive planning prior to making these decisions on when and how to transition out of the workplace are so critical. 

The Triplett-Westendorf Purpose and Timeline 5 Step Process (PT5) specifically address healthcare expenses along with the many other variables that must be evaluated before making decisions that affect the rest of your life. However, with proper planning and attention to detail it is possible to retire with purpose, and do it on your desired time! 

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