According to a recent study from insurance company Allianz
Life, nearly half of retirees aren't tracking what they spend on healthcare.
Given that healthcare stands to be a retiree's largest expense, flying blind in
this area of one's budget could be a disastrous move.
Head off a financial crash-and-burn with a reality check on
how much you could end up spending on healthcare, why you should be monitoring
that spending, and strategies you can take before and during retirement to
manage this major expense.
What healthcare could cost you
A paper from the Center for Retirement Research at Boston
College pegged retirees' actual healthcare spending in 2017 at $4,300 monthly.
That's $51,600 per year and nearly three times the average retiree's Social
Security income.
Even more shocking are recent projections of the average
cumulative healthcare costs retirees will absorb over the course of retirement.
A 2019 HealthView Services report estimates that a 65-year-old couple will
spend more than $600,000 in total on out-of-pocket medical costs. A 2020
analysis from Fidelity offers a slightly more palatable estimate of $295,000 in
cumulative healthcare expenses for 65-year-old couples who retire this year.
Why track your healthcare spending
High healthcare expenses pose a double threat to your
finances. The first threat is obvious -- healthcare expenses can be high enough
to consume a giant chunk of your income. The second threat is their rate of
growth. Healthcare expenses have very high rates of inflation, averaging 4.9%
per year, according to HealthView Services. That means if you spend $50,000
this year on medical costs, those expenses could easily tick up to $52,450 next
year -- with no change at all in your health. After 10 years, a 4.9% inflation
rate would raise that $50,000 total to more than $80,000.
For some perspective, the 2021 Social Security
cost-of-living adjustment is 1.3%, well short of the healthcare inflation rate.
If your healthcare costs rise nearly 5% annually and you don't trim spending in
other areas or find another source of income, you likely have to increase your
retirement savings distributions to keep up. And that could lower your earnings
power and put your future solvency at risk.
Monitoring your healthcare spending now won't lower your
costs, but it does tell you where you stand. And that's a critical piece of
information. If there's financial trouble ahead, you're better off knowing
about it now so you can take action.
Manage costs three ways
Possibly the most effective strategy for controlling
healthcare costs is committing to a healthy lifestyle. You already know the
basics here. Get regular exercise, eat a balanced diet, and avoid health-sapping
habits like smoking and excessive drinking. Plan on asking your physician for
more detailed and personalized recommendations.
Secondly, shop around for healthcare plans that pay for more
of the services you need. Traditional Medicare doesn't cover dental, vision, or
hearing services, for example, but some Medicare Advantage plans do. Also,
consider your prescription drug needs and whether these are better served with
traditional Medicare and a Part D plan or Medicare Advantage.
Plan on taking the medical expense tax deduction as well.
Unreimbursed medical expenses, including premiums, that exceed 7.5% of your
adjusted gross income in 2020 are tax-deductible. In 2021, those expenses must
be greater than 10% of your adjusted gross income. You do have to itemize to
get these deductions. But once you are tracking your healthcare expenses
closely, the process of adding them up and documenting them for your tax return
should be straightforward.
Future retirees: Save in an HSA
Saving in a Health Savings Account or HSA is another
powerful strategy for managing your retirement healthcare expenses. There's a
catch, though. You're only eligible to contribute to an HSA if you're not yet
enrolled in Medicare and you currently have a high-deductible health plan. Meet
those requirements and an HSA can save you thousands in tax dollars over the
course of your retirement.
Here's how the HSA works: Funds you contribute to an HSA are
tax-deductible. As with the money in your IRA, you can invest it and your
earnings are tax-deferred. You can also take tax-free withdrawals at any time
as long as you use the money to pay for healthcare -- a potentially lucrative
perk you won't get from your 401(k) or IRA. Withdrawals for nonmedical purposes
are subject to regular income tax plus a 20% tax penalty until you turn 65.
After 65, the penalty drops away and you only pay income tax on the nonmedical
distributions, just like you would in your 401(k).
It's not too late
It's never too late or too early to plan for your healthcare
costs in retirement. If you still work and are eligible for an HSA, contribute
whatever you can to that account today.
If you're already retired, start monitoring your current
spending on healthcare premiums and other out-of-pocket medical costs. Then,
consider how those expenses might evolve over time and whether you need to trim
other areas of spending or find another source of income to provide a financial
cushion. In the meantime, get some healthy living advice from your physician,
shop around for more suitable coverage, and take your medical expense tax
deductions.
And, yes, all of this is more work than flying blind -- but
given what healthcare expenses can cost you in retirement, there's enough
upside to justify your efforts.
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