Strategies to Pay for Retiree Health Care Costs

When you draw up a retirement-spending budget, you're likely to account for utilities, car insurance and lawn care. But have you given the cost of health care a hard look—or are the numbers too scary to contemplate?

One of the most important moves preretirees can make is to see that “their financial plan explicitly accounts for health costs in retirement,” says Sunit Patel, senior vice-president of Fidelity Benefits Consulting. On average, a couple age 65 will spend $220,000 on health care costs during retirement—and that does not include potential long-term-care costs, according to new estimates by Fidelity Investments.

When preparing a retirement budget, include a line item for health care that includes monthly premiums for Medicare Part B, a Part D prescription-drug plan and a Medigap supplemental insurance policy—plus an extra allocation for uncovered drug and other expenses. A Medicare Advantage plan could cost somewhat less. Adjust estimates for inflation, perhaps at 5% a year. If you believe you will live longer than average, plan for those additional years.

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Prepare for unexpected spikes in costs, such as the $10,000 dental bill. Traditional Medicare does not cover the costs of dental or vision care, and few Advantage plans do. Nor does Medicare cover long-term care. For such expenses, be sure to set aside a large emergency reserve that you should not include when counting monthly retirement resources.

Create new income streams. Once you project your recurring monthly costs, you could buy an annuity to pay for part of those expenses. One option is a deferred fixed-payment annuity. Say you’re a 60-year-old female and you want to create a monthly guaranteed income stream of $400 to cover part of your out-of-pocket medical expenses starting at age 65, when you enroll in Medicare. You would pay $64,000 to an insurance company, according to ImmediateAnnuities.com. If you don’t need the payouts until 70, you’d pay $44,000. One downside: The payments do not rise with inflation.

Also consider delaying Social Security and allocating part of that higher benefit to Medicare premiums. Assume you’re due a $2,000 monthly benefit at full retirement age (age 66 for those born between 1943 and 1954). If you claim at 62, your lifetime benefit would be reduced to $1,500. That extra $500 a month could cover the standard Part B premium as well as average premiums for Part D and Medigap policies—totaling about $365 a month in 2014. Your Social Security benefit will rise with inflation.

You can also sock away extra money if you delay leaving your job. Fidelity estimates that a couple could save $20,000 if they postpone retirement until 67. Meanwhile, a couple who retires at 62 could spend $17,000 a year on out-of-pocket health costs until they enroll in Medicare at age 65. Those costs include premiums for individual policies the couple would need to buy once subsidized employer-sponsored coverage ends.

At age 62, you could consider a reverse mortgage, which you can set up as a line of credit or monthly income stream. You or your heirs must pay back the loan, with interest, when you die, sell the house or move out for more than 12 months.

Avoid the surcharge. Medicare beneficiaries pay higher Part B premiums if their annual modified adjusted gross income exceeds $85,000 for singles or $170,000 for couples. Over an average life span, an individual in Massachusetts who is 55 today could expect to pay $216,492 on Part B and Part D premiums on income lower than $85,000 a year, according to HealthView Services, a company that helps financial advisers estimate clients' lifetime health costs. If AGI exceeds the top surcharge threshold of $214,000, the beneficiary could pay $666,932. (There are five income thresholds, with surcharges increasing at each one.) The standard Part B premium is $104.90 in 2014.

Preretirees and current beneficiaries can lower or reduce future surcharges by keeping AGI from reaching into a higher threshold, says Ron Mastrogiovanni, HealthView’s president and chief executive officer. Since Roth IRA income does not count toward AGI, Mastrogiovanni notes that conversions before or early in retirement “could save hundreds of thousands of dollars” in income-related Medicare premiums. He also points out that qualified withdrawals from a health savings account do not count toward AGI.

Tap life insurance. With most permanent life insurance policies, you can take tax-free withdrawals or loans from the accumulated cash value to pay for health care and other expenses. (These don't count toward AGI, either.) However, if you take a withdrawal or don't pay back the loan, you reduce the death benefit for heirs.

Several companies are offering new life insurance features aimed at retirees who may face big health care expenses. Earlier this year, New York Life introduced a "chronic care rider" that buyers can add to whole-life policies at a cost of 4% to 5% of the premium. The rider enables a policyholder to get accelerated death benefits if he or she becomes cognitively impaired or needs help with two out of six activities of daily living, such as dressing or bathing.

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If you don't want to shell out money for a long-term-care insurance policy that you may never use, consider a policy that combines life insurance with long-term-care protection. A hybrid policy provides a death benefit for your heirs and a pool of money you can use for long-term care. Funds used for care would reduce the death benefit; if you never need long-term care, your beneficiaries receive the full death benefit.

New York Life's Enhanced Asset Preserver hybrid policy illustrates how this works. Unlike a standalone long-term-care policy, you don't pay regular premiums but instead pay a single premium. Say you're a 60-year-old female who pays $100,000 upfront. If you need long-term care, the policy will pay up to $344,966 for such services. If you don't need care, there's a $198,968 death benefit for your heirs. "You're always getting back more than you put in," says Craig DeSanto, New York Life senior vice-president.

Stay in-network. Seeking care outside your medical plan's provider network can be a budget buster for early retirees in individual plans, enrollees in Medicare Advantage plans and people who hold policies with high deductibles. You could pay nothing if you see a network provider, but many thousands of dollars if you visit a non-network doctor, hospital, lab or other provider.

Before going out of network, check with a plan to see how it reimburses for out-of-network care, says Robin Gelburd, president of FAIR Health, a nonprofit that provides consumers with health cost data. "You don't want to be hit by a surprise," she says.

Health plans cover out-of-network costs one of two ways. One method is to pay a provider a percentage of the "usual and customary charge" (UCR). The other is to pay a multiple of the Medicare fee schedule.

Say you need a colonoscopy with anesthesia. Total physician charges in a Maryland suburb would be $2,435, according to FAIR Health's medical cost-lookup tool (www.fairhealth.org). Using the tool, you can see what your out-of-pocket costs could be if you see an out-of-network physician in your community.If your plan reimburses at the typical 70% of the UCR, you would pay $730 out of pocket. A plan that pays physicians based on 140% of the Medicare fee, typical for Medicare-based reimbursements, would sock you with a $1,936 bill. If you went with in-network doctors, you could pay nothing.

Gelburd also says that some people "who are trying to stay in-network unwittingly go out of network." While your surgeon and hospital could be in-network, the anesthesiologist or radiologist could be outside the network—and you'll get stuck with the bill. She suggests that patients check out the network status of those specialists.

Sock away cash. For those who qualify, a health savings account is "a fantastic vehicle" to build a kitty to pay for health care costs in retirement, Fidelity's Patel says. "Contributions go into the account tax free, accumulate tax free and come out at the back end tax free" to pay for medical expenses, including Medicare premiums, after age 65, he says.

If you enroll in an "HSA compatible" high-deductible policy with your employer or in the individual market, you can set up an HSA at a bank or brokerage firm. In 2014, you can contribute pretax or tax-deductible money to fund the HSA—up to $3,300 for singles and $6,550 for a family—plus an extra $1,000 contribution if you're 55 or older.

You can contribute every year, and the money grows tax free. You can withdraw the money at any time to pay for medical expenses, but why not let it grow? Once you're on Medicare, you can't contribute anymore, but you can keep the account. Consider this: If you and a spouse put away $7,550 a year starting at 55 in an HSA, you'll have about $112,000 tax free when you enroll in Medicare at age 65. That assumes a 5% rate of return on your investments.