Guidance

RESOURCES TO HELP SHAPE YOUR FINANCIAL FUTURE

According to healthcare cost projection software company, Healthview Services, a healthy 65-year-old couple retiring this year can expect to spend $322,000 (today's dollars) on Medicare premiums and dental insurance.

Add deductibles, copays, hearing, vision, and dental cost sharing, and that figure rises to $404,000. Future public policy decisions could increase these figures if the federal government implements reforms to Medicare—such as premium support—that would shift a greater share of the out-of-pocket burden to retirees. For most people, this means healthcare will be one of their largest expenditures in retirement.

Accordingly, pre-retirees would be well-served to carefully evaluate planning strategies that can help mitigate retirement healthcare costs. Retirement timing, and two tax-advantaged vehicles that can play a role—health savings accounts and Roth IRAs—are three areas to consider.

Delayed Retirement
One approach to hedge healthcare costs is to work a bit longer and delay filing for Social Security. A delayed filing can boost retirement income significantly. Social Security's primary insurance amount rises by 8% for every 12 months of delay beyond full retirement age (currently 66) until age 70—a powerful boost to income that can help fund rising healthcare costs. Furthermore, the annual cost-of-living adjustment helps keep up with inflation, albeit at a slower pace than medical inflation. Working longer also means more net years of employer-subsidized health insurance (and fewer years of Medicare premiums and out-of-pocket costs). It also provides an opportunity to save more in a 401(k), perhaps utilizing catch-up contribution limits.

HSAs
Health Savings Accounts are available to workers in high-deductible health insurance plans. The accounts can be used to meet ongoing deductible and other out-of-pocket healthcare costs. This year, plans can have a maximum out-of-pocket cost of $6,550 for individuals and $13,100 for families. Some employers help offset those costs with contributions to the accounts; this year, combined employer-work contributions can be made up to a combined total of $3,400 for individuals and $6,750 for workers with family insurance coverage. After age 65, an HSA can be used to pay a variety of qualified medical expenses, including Medicare premiums (with the exception of Medigap premiums) or long-term care premiums. Details can be found in IRS publication 969.

The tax benefits associated with HSAs are compelling. Contributions are tax-deductible, investment growth and interest are tax-exempt, and withdrawals spent on qualified medical expenses also are tax-free. Note, however, that funds withdrawn for nonmedical expenses are taxed at the account holder's marginal tax rate; if before age 65, the funds are subject to an additional 20% penalty. Further, HSAs do not have required minimum distribution requirements, and they are portable as they are individually owned and not tied to employers. The triple tax benefit increases buying power, especially when compared with the benefit of drawing down from a 401(k), which is subject to ordinary income tax on contributions and investment gains.

High-income retirees can enjoy another tax benefit from HSAs in that qualified withdrawals are not reported as income, which means they are not counted in the formula that determines whether you must pay high-income surcharges on Medicare Part B or D premiums. One caveat: it is important to carefully navigate the interaction of HSAs and Medicare during the transition period away from workplace insurance. The key issue is that HSAs can only be used alongside qualified high-deductible health insurance plans, and Medicare does not qualify as a high-deductible plan. That means that if a worker or a spouse covered on the employer's plan signs up for Medicare coverage, the worker must stop contributing to the HSA, although withdrawals can continue.

HSAs have been around only since 2003, however, and thus far long-term investing has taken a back seat to usage of the accounts to meet current expenses. To wit, 96% have their funds in cash, according to research by the Employee Benefit Research Institute. A recent Morningstar study further noted that 10 of the most popular HSA plans offer mediocre and high-cost investment options. And just one of the plans was found to be compelling for use as both a spending vehicle and an investment vehicle.

While most HSAs are not structured to be strong as both spending and investing accounts, many experts think health savings accounts will evolve into a platform for long-term saving to meet retirement healthcare costs. If you are eligible for an HSA, the right plan can be a powerful tax-advantaged vehicle.

Roth IRAs
Finally, if you are not eligible for an HSA, investing in a Roth IRA—or doing a Roth conversion—can provide a second-best option. Much will depend, of course, on the specifics of your tax situation. Roths get the income tax out of the way upfront, allowing tax-free withdrawal of contributions and investment returns down the road. Roths also are not subject to required minimum distributions (during the lifetime of the owner), which means you can preserve assets to meet healthcare expenses.

Be mindful that conversions can bring some undesirable near-term tax consequences. To avoid these, consider conversions in low-marginal-income tax bracket years, especially in the years before claiming Social Security. A series of small Roth conversions that maximize taxable income in your tax bracket can make good sense. Backdoor Roths offer another option.

Contact your Financial Advisor to discuss planning strategies best suited to help you manage healthcare costs in retirement.