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Posted: 4/16/2019 by Fidelity Viewpoints
* HSA contributions, earnings, and distributions used to pay for qualified medical expenses are tax free for federal income tax purposes.
If you are like most Americans, you expect health care to be one of your largest expenses in retirement, after housing and transportation costs. But unlike your parents' generation, most of you won't have access to employer- or union-sponsored retiree health benefits. So, health care costs will likely consume a larger portion of your retirement budget—and you need to plan for that.
There are a number of drivers behind this mounting retirement health care cost challenge. In general, people are living longer, health care inflation continues to outpace the rate of general inflation, and the average retirement age is 62 for most Americans—that's three years before you are eligible to enroll in Medicare.
"Health care is creating a 'retirement cost gap' for many pre-retirees," says Steve Feinschreiber, senior vice president of the Financial Solutions Group at Fidelity. "Many people assume Medicare will cover all your health care cost in retirement, but it doesn't. We estimate that about 15% of the average retiree's annual expenses will be used for health care-related expenses,² including Medicare premiums and out-of-pocket expenses. So, you should carefully weigh all options."
How much should you plan to pay in health care costs after you retire? According to the Fidelity Retiree Health Care Cost Estimate,² an average retired couple aged 65 in 2019 may need approximately $285,000 saved (after tax) to cover health care expenses in retirement. Of course, the amount you'll need will depend on when and where you retire, how healthy you are, and how long you live. The amount you need will also depend on which accounts you use to pay for health care—e.g., 401(k), HSA, IRA, or taxable accounts; your tax rates in retirement; and potentially even your gross income.3
Tip: If you're still working and your employer offers an HSA-eligible health plan, you are eligible to contribute to a health savings account (HSA). An HSA offers a triple advantage.4 You can save pretax dollars (and possibly collect employer contributions), which have the potential to grow and be withdrawn tax free for federal tax purposes if used for qualified medical expenses—now or in retirement.
As retirement nears, you will have several big decisions to make, including when to stop working, when to take Social Security, how to pay for health care, and how to generate cash flow from your retirement assets. These decisions are interconnected and could make a difference in your living costs and lifestyle in retirement—and when you can retire.
Some one-third of "early retirees" who claim Social Security at age 625 do so to help pay for health care expenses until they are eligible for Medicare coverage at age 65. But if you can postpone retirement or save enough to cover health care costs until age 65, then you may be able to defer your Social Security benefits. Generally speaking, the longer you can wait to take Social Security benefits, the more you can collect, assuming you live a long life.
If you're like most people, you probably don't have access to employer-sponsored pre-65 retiree medical coverage. So if you retire prior to age 65, you'll need to find coverage until you are eligible for Medicare. Consider these options that may be available to you (see chart below).
When you get close to age 65, spend some time reviewing and considering all your Medicare options. When you do become eligible at age 65, you'll want to remember to sign up during your seven-month initial enrollment period that begins three months before the month you turn 65.
There's a lot to learn about the world of Medicare. You'll need to know about Medicare Parts A, B, and D, as well as Medicare Advantage and "Medigap" supplemental insurance plans.
Tip: You may be better off paying a higher premium but not having to pay out of pocket at your office visits. Look at the cost of annual premiums and co-pays at different levels of supplemental insurance. Compare these costs. Then factor in the number of visits and co-pay/coinsurance per visit that you anticipate for the next year.
Once you select a Medicare plan, it's not forever. You can switch Medicare plans as you age and as your situation changes. Generally, it makes sense to enroll in Medicare Parts A, B, and D when you are first eligible because the late enrollment penalty for doing so later is steep (see next section if you are continuing to work after age 65).
For illustrative purposes only. Source: Fidelity Benefits Consulting 2018.
If you're still working when you're 65 and get health insurance through your employer or your spouse's employer, you'll have the opportunity to enroll in Medicare when you leave your employer plan through a Special Enrollment Period.
In addition to Medicare options to consider, if your spouse or partner continues to work, they may be able to cover you through their health plan. Ask your HR department to help you evaluate all your options, costs, and any restrictions. The rules of Medicare are complicated, so to get started, consider the following questions:
Tip: Remember, one of the key goals at this stage is to avoid any gap in coverage.
As you plan for health care expenses throughout your retirement—however long it may be—understand how paying for them fits into your overall retirement income planning efforts because health care utilization tends to increase as we age.
According to the Kaiser Family Foundation, the percentage of household budgets spent on health expenses is nearly three times as much for retirees on Medicare as for working households (14% versus 5%).6
"Although health care costs continue to rise, there are financial planning steps that you can take today to help prevent health care costs from eating into your retirement lifestyle," Feinschreiber advises. "For example, if you're age 50 or older, you may be able to make up for a savings shortfall with additional catch-up contributions to your 401(k) or IRA. In addition, if you are age 55 or older, you can make an additional $1,000 catch-up contribution annually to your health savings account."
Fidelity does not provide legal or tax advice. The information herein is general in nature and should not be considered legal or tax advice. Consult an attorney or tax professional regarding your specific situation.
The information provided herein is general in nature. It is not intended, nor should it be construed, as legal or tax advice. Because the administration of an HSA is a taxpayer responsibility, you are strongly encouraged to consult your tax advisor before opening an HSA. You are also encouraged to review information available from the Internal Revenue Service (IRS) for taxpayers, which can be found on the IRS website at IRS.gov. You can find IRS Publication 969, Health Savings Accounts and Other Tax-Favored Health Plans, and IRS Publication 502, Medical and Dental Expenses, online, or you can call the IRS to request a copy of each at 800-829-3676.
1. Fidelity Benefits Consulting estimate, 2019. Estimate based on a hypothetical couple retiring in 2019, 65 years old, with life expectancies that align with Society of Actuaries' RP-2014 Healthy Annuitant rates with Mortality Improvements Scale MP-2016. Actual expenses may be more or less depending on actual health status, area of residence, and longevity. Estimate is net of taxes. The Fidelity Retiree Health Care Costs Estimate assumes individuals do not have employer-provided retiree health care coverage, but do qualify for the federal government's insurance program, Original Medicare. The calculation takes into account cost-sharing provisions (such as deductibles and coinsurance) associated with Medicare Part A and Part B (inpatient and outpatient medical insurance). It also considers Medicare Part D (prescription drug coverage) premiums and out-of-pocket costs, as well as certain services excluded by Original Medicare. The estimate does not include other health-related expenses, such as over-the-counter medications, most dental services, and long-term care.
2. Fidelity Benefits Consulting estimate, 2019.
3. For investors with MAGI above $170,000 in the calendar year two years before the current year, and filing taxes as married filing jointly, Medicare premiums for parts B and D are increased.
4. With respect to federal taxation only. Contributions, investment earnings, and distributions may or may not be subject to state taxation.
5. Social Security Administration; https://www.ssa.gov/policy/docs/ssb/v76n4/v76n4p1.html.
6. Kaiser Family Foundation, Health Care on a Budget: The Financial Burden of Health Spending by Medicare Households, 2014.