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Healthcare in Retirement: How to Plan

By Justin Pritchard, CFP®

For most people, healthcare is an employer-provided benefit during your working years. Unless you’re self-employed, you’ve probably received healthcare benefits from an employer. At retirement, that may change. It’s crucial to understand how much healthcare costs in retirement and how you’ll pay for healthcare in retirement.

With this information, you’re better prepared to plan, and you’ll understand how to save for healthcare costs. 

You’ve probably seen big, intimidating numbers projecting healthcare costs in retirement. For 2022, Fidelity estimates that a 65-year-old couple will need $315,000 (or more) throughout retirement for healthcare costs. A Vanguard and Mercer study estimates that a 65-year-old woman with Medicare might spend around $7,000 on premiums and out-of-pocket expenses each year (assuming some high-risk health issues). More on these numbers below.

One of the biggest factors is whether you retire before or after you reach age 65. Also, it’s important to know if your employer provides retiree healthcare.

Before Age 65 (Early Retirement)

Pills shaped as question mark indicating questions about healthcare expensesMedicare, as we’ll discuss below, is typically available at age 65. But if you retire before that age, you’ll still need health insurance. This is, perhaps, one of the most challenging times when it comes to healthcare. You may be at an age where healthcare is costly, and you may not have many options. 

For most “early” retirees, several options are available:

  1. Switch to a spouse’s plan (if applicable)
  2. COBRA or state continuation
  3. Private health coverage
  4. Health sharing arrangements

Spouse’s Coverage

If you happen to have a spouse who will keep working, you may be able to switch to their plan. That’s obviously not an option for singles, widows, unmarried partners, or couples who plan to retire at the same time. But for some, it’s a possibility.

When you stop working for your employer, that may be a “qualifying event” that enables you to qualify for coverage under a spouse’s plan.

But let’s move on to more likely options.

COBRA or State Continuation

When you terminate employment, you may be able to keep your existing health insurance from your employer for a limited time. Under COBRA (or, for small companies, your state’s continuation of benefits rules), your healthcare plan may be available for another 18 months after you retire.

While that’s good news, the bad news may be how much you pay. You typically have to pay the full cost of the health insurance yourself. Your employer may have been paying a portion of those costs previously, so you may face a payment shock. Ask your benefits coordinator or HR department for an estimate of how much you’ll pay for healthcare when you retire (ideally, ask this several months or years before retirement).

Important: If you’re anywhere near age 65, be careful about continuing your benefits. Missing Medicare’s age 65 enrollment deadline can cause problems even if you’re still on COBRA.

Private Health Coverage

You can always buy health insurance from insurance companies on your own, even if your employer provides coverage. In most cases, this only makes sense when you have no employer-provided healthcare available. Once you check pricing for those policies, you’ll understand why.

Still, if you’re heading into retirement, you need coverage. Going uninsured is just too risky.

You can get private coverage directly from insurers, or depending on your state, through a state healthcare exchange. It’s always worth checking to see what resources your state makes available, as that may help you narrow down the options available to you (based on the city or county you live in, for example).

Tip: Several months (or years) before retirement, visit your state’s insurance marketplace and get several quotes. The prices will probably rise over time, but you’ll get a ballpark idea of your retirement health insurance costs.

If your income is below certain limits, you might even get subsidies to reduce (or eliminate) the premiums you pay for your individual or family coverage.

Health Sharing Arrangements

You may have heard about health “sharing” programs, which function similarly to health insurance. These programs have several drawbacks, but they’re worth mentioning because you may come across them in your research. Monthly premiums tend to be lower than what you pay for health insurance, which gets everybody’s attention.

Health sharing ministries and similar programs are not insurance. They may limit benefits on pre-existing conditions, they may not provide the prescription drug coverage you want, and they might not even pay benefits in some cases (they’re considered “voluntary,” and not necessarily required to cover your needs).

To qualify for these arrangements, you may need to meet certain ideological or behavioral requirements. Plus, these organizations are not required to offer the same protections to consumers as insurance companies under state and federal laws.

Given the subjective nature of whether or not you qualify, these might not be the most conservative option. As the Advisory Board states, “health sharing ministries have no legal obligation to cover claims.”

After Age 65

When you reach age 65, things get simpler. Medicare is the predominant form of healthcare in retirement, and some people even qualify before age 65. Unless your employer offers retiree health insurance, you’ll probably end up on Medicare.

Medicare

Medicare costs come in several forms, and you’ve probably been paying a portion of your Medicare costs throughout your working years. It’s critical to know if you’re covered under Medicare and meet specific deadlines to avoid paying penalties.

As a quick refresher, some essential pieces of Medicare are:

  • Medicare Part A (hospital insurance) is funded from payroll taxes, and as long as you have at least 40 qualifying quarters on your—or your spouse’s—work record, you do not pay a Part A premium.
  • Part B premiums (medical services) are $148.50 per month. However, you may pay more, depending on your income.
  • Part D (prescription drug coverage) costs vary by plan, and you have a variety of choices to choose from.
  • Supplemental or Medigap coverage allows you to purchase additional coverage that may be appropriate for your health conditions and preferences. Medicare does not cover everything, so these plans can fill some of the gaps. Note that you still may need a Part D plan.
  • Medicare Advantage plans are private insurance offerings that provide “all in one” coverage coordinated with Medicare. 

How Much Will Medicare Cost?

Several studies try to estimate how much the average retiree spends on healthcare each year. Your actual costs will depend on your health, where you live, and other factors. But we can get some rough ideas about costs from national averages.

Again, the Mercer-Vanguard study (described more below) does an excellent job of showing some expected costs for retirees using Medicare, including those who use a Medigap plan. That study points out that the total costs depend on what supplemental plans you use, what risk factors you have, and more.

Employer’s Retiree Healthcare

If you’re fortunate enough to get health coverage after retirement from your employer, it’s worth evaluating all of the alternatives. Compare pricing for your employer’s plan and any private healthcare available to you. In some cases, it may make sense to pass on your employer’s offering.

How to Save for Healthcare

Once you know what to expect and roughly how much healthcare might cost, it’s ideal to save for retirement healthcare costs. You’ll probably also get income each year from Social Security or a pension, and that money can also go toward health-related expenses. But it’s always nice to have a rainy day fund for major medical events.

So, where should you save money? You have several options.

Health Savings Accounts (HSAs)

HSAs are ideal for saving money for health expenses, and they provide triple-tax benefits:

  1. Dollars going in may be deductible.
  2. Growth and income inside of the account may be tax-deferred.
  3. Withdrawals you take for qualifying medical expenses may be tax-free.

Drawbacks of HSAs are that you need to be eligible to contribute each year (by having a qualifying high deductible health plan), and IRS limits may prevent you from saving as much as you’d like. You may be accustomed to spending money from your HSA each year, but you don’t have to do that. You can keep the money in your HSA until retirement and spend the money later.

Other Retirement Accounts

If you’re saving money in any type of retirement account, that’s great. That money is for expenses in your retirement years, and healthcare expenses are one of those expenses. A 401(k), 403(b), SEP, SIMPLE, IRA, or TSP is a logical place to save for your future. You can even prepay the taxes if you’re allowed to make Roth contributions.

Taxable Accounts

You can also use standard “taxable” accounts like a joint or individual brokerage account to save for your future. Although you may have tax consequences, the money is available for spending at almost any time. That’s particularly helpful if you retire before age 59.5.

How to Budget for Healthcare in Retirement

Unfortunately, we can’t predict the future. Healthcare costs depend on your health conditions, your good (or bad) luck, your location, and future legislation. That said, we can make some educated guesses right now, and online tools and financial advisors can help you gain clarity.

Back to the Studies

Fidelity estimates a need of $315,000 for a 65-year-old couple retiring today, and a bit less for singles ($165,000 for women and $150,000 for men).

Those numbers, while perhaps staggering, do not include certain out-of-pocket costs or long-term care expenses. But if we break it down, it may be less intimidating. Assuming a 20-year retirement, that’s more like $14,750 per year (for a couple).  Your retirement may be longer or shorter than that.

In some years, you may pay more, and in some years, you may pay less. Again, this doesn’t necessarily include every cost, but it’s a start. If you get Social Security or pension income each year, those payments can help cover your healthcare cash flows. As a result, it can be possible—if the conditions are right—to retire with $500,000 of savings (or less).

All-in costs: In the Mercer-Vanguard study, we see a particularly useful number: An all-in estimate of healthcare costs for a retiree. That includes Medicare premiums as well as other out-of-pocket costs like dental and vision expenses (basic Medicare does not cover those expenses). 

  • A 65-year-old woman with several health issues might pay $2,900 in premiums (for Plan N) and $3,900 out of pocket, for a total of $6,800
  • With better health, she might pay only $1,900 out of pocket, for a total of $4,800 for the year
  • With particularly bad health, she may spend upwards of $10,000 out of pocket

Rising Costs (Inflation)

As you budget for healthcare expenses, it’s important to calculate the effects of inflation. Healthcare costs have been rising, and it’s probably smart to assume that healthcare inflation will be faster than broader price increases. An inflation pace at around 5% is prudent, and a higher number would be safer.

Long-Term Care

If you need long-term care, such as memory care or high-level care in a nursing home, things can get expensive quickly. You may face additional costs that range from a few thousand per month to over $10,000 per month. Again, it depends on your location and the level of care you need. Long-term care insurance policies are available, but there are pros and cons of going that route, and it’s not for everybody. Most importantly, you need to be aware of the possibility of catastrophic costs.

Make a Plan!

Now that you know what to expect, is your plan in order? Ideally, you’re saving money for future healthcare costs, and you have some idea of how much retirement income you’ll receive. Put all that together to find out if you’re on track to cover ongoing health expenses (as well as a few surprises) throughout your retirement years.

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