Retiree Medical Costs Will Dent Social Security Benefits unless You Plan Now

Retiree Medical Costs Will Dent Social Security Benefits unless You Plan Now

Like death and taxes, medical expenses in retirement are inevitable. Those who fail to plan -by saving enough and placing those funds in the right long-term account - will see more and more of their Social Security income go to pay for medical coverage and care.

A recent article explains that Social Security recipients pay an average of 30% of their monthly benefit on medical and other health-related expenses. That figure is probably a wake-up call to many Americans. Even those who've saved some money for retirement - and thus are paying at least a portion of their medical expenses from savings rather than Social Security income - aren't aware of the bite that medical coverage (insurance) and care (services) will take out of their retirement budgets.

Here, as in many cases, ignorance isn't bliss. It's potentially disastrous. But we all have agency - the ability to control our situations. And some up-front knowledge and planning can lead to very different financial situations in retirement.

Nothing New

This article isn't news to those who understand the impact of medical coverage and care in retirement. Fidelity's estimate of remaining medical costs for a couple retiring at age 65 in 2021 is $300,000. HealthView projects a figure of $662,000, with a range between $156,000 and just over $1 million. The Employer Benefits Research Institute estimates that the same couple would need $182,000 to have a 50% chance of meeting their needs and $301,000 for a 90% chance.

And note that these figures reflect medical, prescription drug, dental, and vision expenses. They don't include the cost of long-term care, which in much of the country can exceed $100,000 annually.

What drives these figures?

Medicare premiums: Most Part A (which covers inpatient care) enrollees prepay their premiums through payroll taxes during their working years. But Part B (outpatient services, including physician visits, labs and testing, most cancer therapy, and physical therapy) premiums total more than $2,000 annually. Part D (prescription drugs) premiums vary and are often $400 to $700 annually. Those two premiums total $50,000 per person over 20 years of retirement at today's (not inflation-adjusted) dollars. And double that to $100,000 for a couple.

Medicare out-of-pocket expenses: Medicare care isn't cost-free. Part A imposes a $1,556 deductible for each hospital visit for a new condition (not a readmission). Thus, a patient can incur multiple deductibles in a single year. Plus, full coverage (after the deductible) for inpatient days is limited to 60 days per condition, after which patients pay a $389 or $778 daily copay, or receive no coverage.

Part B has a $223 deductible, then patients pay 20% of all remaining eligible costs. To put this structure in perspective, consider $30,000 of outpatient expenses for cancer treatment. Patients are responsible for $6,000.

Part D out-of-pocket costs can be several thousand dollars annually for patients with moderate prescription drug costs.

Medicare enrollees can share some of their out-of-pocket exposure under Part A and Part B by purchasing a Medicare Supplement policy at a cost of $1,800 to $3,600 per person annually.

Expenses not covered by Medicare: Bodies, like automobiles and a home's utility systems, require more spending with age to maintain functionality. Medicare doesn't cover most dental, vision, or hearing expenses, or over-the-counter drugs, medicine, equipment, and supplies. Thus, enrollees are on the hook for the full cost of dental fillings, implants, crowns, and bridges; prescription glasses and contact lenses; hearing aids; and over-the-counter arthritis medicine, incontinence products, and immune-system boosters.

Choosing the Right Savings Account

Many Americans save for projected retirement expenses. After all, they probably will no longer generate earned income - whether by choice or not - yet will continue to need to pay for housing, food, clothing, transportation, taxes, and other expenses. They can place their funds into one of three categories of accounts:

Tax-deferred accounts: Tax-deferred 401(k) (and similar) plans and Individual Retirement Arrangements (IRAs) offer tax savings on the front end. Contributions are free of federal or state income taxes (either pre-tax or tax-deductible), but payroll taxes are assessed. Imagine a one-time contribution of $100, which would be $92.35 after payroll taxes are assessed. If that contribution grew at 6% annually for 30 years, the total would grow to $500 after 30 years. When it's spent, taxes are, say 17%, which leaves the retiree with $415 in spending power.

Roth accounts: Roth 401(k) plans and IRAs are funded with after-tax funds. That one-time $100 contribution shrinks to $67.35 after payroll taxes and 25% combined federal and state income levies. The result? The account grows to $365 at a 6% return over 30 years. The owner can withdraw the $365 without taxes. That's less than the $415 spending power of the funds deposited into the tax-deferred account because we assumed that income taxes are less for the average retiree because (1) income is lower and (2) many retire to warm-weather states like Florida and Texas that don't tax incomes. Change the assumptions and the spending power can be adjusted.

Health Savings Accounts: Federal and state (except in California and New Jersey) incomes taxes aren't applied to these contributions. In addition, deposits made through an employer's Cafeteria Plan aren't subject to federal payroll taxes, either. In this case, the full $100 is deposited into the account. It grows to $542 (more than the tax-deferred account in which payroll taxes reduced the contribution). Because no taxes are applied to withdrawals for qualified expenses, the full $542 is available to spend.

Hmm . . . which would you rather have: $365, $415, or $542? Remember, each account is funded with the same $500 sacrifice of current consumption. But tax friction - or lack thereof - produces very different spending power in retirement. Since most people fund retirement through tax-deferred accounts, let's look at the $127 difference between the same contribution to a Health Savings Account versus a tax-deferred 401(k) or IRA. Now, multiply that figure to reflect a higher contribution in Year 1 and continued funding through the 30 years. If you contribute $2,000 (less payroll taxes in the case of the tax-deferred account) annually for 30 years at a 6% return, your balance after three decades is $128,000 in the tax-deferred account and $167,000 in the Health Savings Account. That $39,000 difference can pay 8% more of your estimated Fidelity expenses than can the same amount deposited in a traditional tax-deferred retirement account.

The Bottom Line

It's not just how much you save. It's about the tax treatment of contributions, balances (identical in all three types of accounts), and withdrawals. Too many Americans are focused on the accumulation phase of retirement. In other words, savings as much as they can. Most don't pay attention to the distribution phase, when taxes play a huge role in determining the spending power of those balances.

Health Savings Accounts win. Hands down. In every comparable scenario. Regardless of assumptions about marginal income tax rates during working years or in retirement.

#HSAWednesdayWisdom #HSAMondayMythbuster #HSA #HealthSavingsAccount #yourHSAcademy #yourHealthSavingsAcademy

William G. (Bill) Stuart

Nationally recognized expert on reimbursement account strategy and compliance, particularly Health Savings Accounts and ICHRAs 🔹Writer🔹Author🔹Speaker🔹Educator🔹Strategist

2y

Not surprisingly, Health Savings Accounts trump tax-deferred and Roth retirement accounts when it comes to saving for medical expenses in retirement. Learn why in this article.

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