Ever since 2002, health care expenses have grown an average of 6% per year which is well over twice the annual inflation rate of consumer prices overall. This statistic is staggering, but it’s still far too easy to overlook the impact of these rising costs on your retirement. In fact, many people still believe, erroneously, that they will be mostly taken care of by government medical programs!
In this article, I’ll walk you through some of the shocking realities of medical expense planning for retirement, how you can estimate your potential savings needs, and the potential for a Health Savings Account (HSA) to help you meet your goals.
The Cost of Healthcare
According to the Employee Benefit Research Institute Medicare covers only about one-half of retiree health care expenses. In fact, a couple with both spouses aged 65 retiring today, with an average life expectancy, could need as much as $295,000 to cover insurance premiums and out-of-pocket expenses throughout their retirement. A couple living to age 95 could need as much as $550,000. Of course, this is just an estimate. Fidelity, which also researched the subject, puts the number at about $240,000, and recommends adding more for women(longer life expectancy)and for those in poorer health.
Where is all this money going? In addition to paying for insurance, deductibles, and copays, retirees often pay for prescription drugs, additional coverage like dental or vision, and long term care. Estimating how much you might need can be tricky, not only because this is a difficult topic to face at the best of times but because of the potential impact of major medical crises. Fidelity offers an online cost calculator, andGoodcare provides a host of background information, checklists, and worksheets on retiree health planning.
Another Savings Option
Generally, I advise that saving for retirement is best accomplished, in my opinion, by consistently setting money aside into your 401(k) or IRA and using professional, active management. However, there is another option, which, if used correctly, can have a powerful impact on your overall savings.
Health Savings Accounts (HSAs) are a tax-efficient savings vehicle for medical expenditures. Contributions to these accounts are completely tax deductible, interest and investments can grow tax-free, and withdrawals made for qualified medical expenses are also exempt from taxation. Using your HSA for medical expenses is also easy as most accounts come with debit cards or checkbooks. You aren’t required to use the account every year so it can grow tax free year after year. Also, like an IRA account, you completely control the money in your HSA and you can invest it in stocks, bonds, mutual funds, CDs, or many other assets, though the custodian of the HSA may have their own rules about what you can invest in. You can even do a one-time rollover from your IRA account into your HSA!
HSAs are available to people who are currently enrolled in high deductible health insurance plans (HDHP) or those who choose to change to one. HDHP require the participant to pay all their medical fees up to a certain amount, after which insurance coverage kicks in (these fees are generally the lower, negotiated rates paid by the insurance company rather than the higher fees you often see in individual health insurance plans). The maximum deductible and out of pocket expenses for such plans was $11,900 for family coverage in 2011, an amount that is regulated by the IRS. This amount does not include premiums or out-of-network services.
While high deductible plans may seem more expensive on the surface due to the shock of seeing doctor’s invoices and paying them, it’s actually possible to enjoy significant savings due to reduced insurance premiums and other charges. Some people find that these savings dramatically reduce their overall health care expenditures. Your HSA could provide additional savings over the long run. Because of the tax-preferred status of these accounts, any savings you accumulate tax free over the years and help fund medical expenses in retirement. You can also make non-medical expense distributions from HSAs, with tax and penalty rules similar to those governing IRA accounts. Of course, before deciding on an HSA alongside a high deductible plan, do your due diligence to see whether it will be more cost effective for your particular circumstances.
It’s important to remember that contribution limits for HSAs are currently at $3,100 for an individual and $6,250 if you have a family, with a $1,000 catch-up contribution for each spouse over age 55 – so it may not necessarily make sense for your HSA to function as a long-term savings vehicle unless you are relatively young or in very good health. Further, while HSAs are free from federal income tax and most state taxes, three states (Alabama, California, and New Jersey) do not allow state tax deductions for contributions to HSAs. Keep in mind that tax laws can always be changed, so it is not guaranteed that HSA accounts will always enjoy such preferred tax status. It is also important to note that high deductible plans necessarily require you to have the means to pay for your medical expenses up to your deductible limit. Therefore, if you anticipate very costly care in the near future, be sure to carefully consider whether a high deductible plan is right for you. Any costs above what you have in your HSA will need to be funded through other sources.
Finally, remember that because an HSA is an investment account, you will need to decide the level of risk you will be able to tolerate. Plan your investment strategy accordingly and with the help of a professional advisor to ensure that you don’t take on more risk than you’re comfortable with.
So how can you use your HSA to help with your retirement? Use it as a tax shelter. Pay your deductible and out-of-pocket expenses from your current cash flow whenever possible and fund your HSA to the limit each year. This way, you can have certainty about your annual medical expenses, which are capped, and take advantage of the tax-free growth and medical expense distributions offered by HSAs. Once you reach retirement, you will potentially have a nice nest egg alongside your other retirement savings to help fund your healthcare needs.
Because health care expenses are consistently rising, the time to consider the impact of medical needs on your retirement is right now. Many people are surprised at the level of savings required to meet insurance costs and other out-of-pocket expenses, so talk with your advisor and take the time to try to build these costs into your retirement savings projections.
When making retirement plans, consider not only your usual retirement savings vehicles but alternatives such as HSAs alongside a high deductible health plan to build tax-free savings for your future medical needs. As hard as it is, taking a hard look at your current health and potential healthcare needs in the future will go a long way towards helping you build in the financial security you deserve in retirement.
To learn about retirement savings, download my free eBook, “10 Tips You Need to Know About Your IRA Rollover.” This short book is packed with critical information that will help you make the right decisions about your retirement savings.
Written by Bradford Pine
Bradford Pine Wealth Group – New York City Financial Advisors
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