Early Retirement Health Costs

Art by Marc Rosenthal

As health-care costs rise and the disparity between how much people think they will need to save and what they will actually need widens, advisers increasingly face the challenge of exploring ways to help retirees pay for their health care. According to Fidelity Investments, health-care costs during retirement are nearly eight times greater than what Americans expect.

Various programs are designed to provide tax advantages to offset health-care costs, though the options are fewer for retirees under age 65 who have no employer-sponsored insurance. One of the most useful resources for such retirees to be able to tap is a health savings account.

Retirees may be able to lower their overall health-care costs by using untaxed dollars they had saved in an HSA to pay for deductibles, copayments and other expenses. HSAs are also useful because, once the holder turns 65, they become a de facto individual retirement account, from which the person may withdraw money for nonmedical purposes, though will have to pay normal income tax. “The HSA tax benefit is second to none,” says Carl Hall, co-founder of HealthyHive, a digital education and consulting platform. HealthyHive works with advisers and specializes in employee HSA education. Hall says advisers should educate their employer and employee clients about the accounts’ advantages.

Hall is also a big proponent of direct primary care, to reduce costs during retirement. Direct primary care is a membership-based, alternative payment model in which patients, employers or health plans pay flat, periodic fees to primary care providers directly for access to medical and prevention services. With direct primary care, patients pay the physician, and there are no third parties or fee-for-service billings.

According to the Direct Primary Care Coalition, about 1,600 DPC practices in 48 states provide access to primary care to over 300,000 Americans.

“Considering a direct primary care physician is a really good way to control the costs,” Hall says. “Nine times out of 10, if you have a doctor at a hospital who says you need an MRI or an X-ray or a CAT scan, it is highly likely you will significantly overpay for those services.”

Retirees under 65 without employer-sponsored health insurance may also use the federal government’s health insurance marketplace to buy a plan at a subsidized rate. And, because losing health coverage qualifies individuals to enroll at any time, vs. waiting for open enrollment as is required for this insurance, those younger retirees would qualify. They may also qualify for a private plan with premium tax credits, as well as extra savings known as cost-sharing reductions.

The amount of the premium tax credit depends on the estimated adjusted gross income a retiree has earned. Dan Johnson, an assistant professor at the College for Financial Planning and a part-time instructor at UCLA, Boston University and Kaplan University, advises clients to lower this income before they turn 65. He suggests using tax-advantaged planning such as taking earnings out of a brokerage account instead of an IRA to receive the lower tax rate.

“[That] money is taxed at capital gains rates,” Johnson explains. “A common strategy is to liquidate stocks that have a higher cost basis, [to minimize] capital gains tax.”

He says this kind of tax planning should also be considered as retirees approach 65—when they become eligible for Medicare—to keep the cost of their premiums down. He notes that the government looks at a retiree’s modified adjusted gross income from two years before the person turns 65, to determine Medicare Part B premiums.

For those who qualify for cost-sharing reductions, the amount saved on out-of-pocket costs ultimately depends on their specific income estimate. Generally, the lower the income within the range, the more they will save.

Short-Term Solutions

Short-term medical plans can also be a more affordable option for those who retire before becoming eligible for Medicare, or who have enrolled in insurance yet to take effect, says Jeff Smedsrud, co-founder of Healthcare.com.

Because short-term medical plans fall outside of the Affordable Care Act, they are not restricted by an open enrollment period and may be signed up for any time of the year. However, this also means they are not required to cover preexisting conditions or to include the 10 essential benefits that the ACA stipulates. Therefore, this is likely a better option for those who are healthy. Wherever the retiree’s insurance comes from, Smedsrud says, what is important is being insured.