Who will pay for your health care in retirement?

Who will pay for your health care expenses in retirement? This is a good question, whether retirement is just around the corner or even if it is still far off in the future. Maybe your answer is “Medicare will pay for it.” And that’s partly true, with emphasis on “partly.” Medicare, the nation’s federal health insurance program for people over the age of 65, pays benefits if you are eligible for Social Security. If you’ve noticed the term “FICA” on your pay stub –that stands for Federal Insurance Contributions Act– you’ve been paying into Medicare.

But here’s the rub: Medicare covers some medical expenses, but not everything. And it isn’t free – you pay Medicare premiums in retirement, and these premiums can increase as the years go by, as can your out-of-pocket expenses. That’s why you need to have a plan to cover your health care costs beyond Medicare.

How much will you need?

"Medicare covers a lot less than people usually think," says Heather Evans, a financial advisor with Merrill. "It can be a huge surprise cost—and your quality of life is going to depend on what you can afford." The experts at Employee Benefits Research Institute (EBRI) agree. A recent EBRI study noted that “Medicare generally covers only about 62% of the cost of health-care services for Medicare beneficiaries ages 65 and older, while out-of-pocket spending accounts for 12% of incurred costs, and private insurance covered 14%."1

So given this, how much will you need to plan on having? According to EBRI, a 65-year-old man would need $142,000, and a 65-year-old woman would need $159,000 to have a 90% chance of having enough savings to cover their health-care expenses in retirement. And a couple with median prescription drug expenses would need $296,000 to have a 90% chance of having enough savings.2 Of course, your needs will depend on a variety of factors, such as your age when you retire, your overall health and your access to quality care.

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Estimate your needs A couple would need $296,000 to have a 90% chance of having enough savings to cover health care cost in retirement,according to EBRI2.

Don’t be put off, it’s time to plan

It’s certainly easy to get intimidated by these numbers. But don’t throw in the towel just yet. The good news is that there are tools and strategies available to help you prepare. “There are many opportunities to take proactive steps to become educated and financially prepared for potential health-care expenses down the road,” says Cyndi Hutchins, Director of Financial Gerontology at Merrill.

Consider these proactive steps:
  1. Run some numbers. To get a sense of what your budget in retirement may look like, check out a few cost calculators (AARP has an easy one to use.) That way you know what you may be dealing with and can plan accordingly.
  2. Don’t put off saving, no matter what your age. Plus, the more time you have to save, the more you will have to spend on health care costs when you need it. It’s important not to gamble with funding health care expenses in retirement; it’s best to be confident that you’ll be able to pay for any serious illness.
  3. Next, take advantage of a Health Savings Account (HSA) if you currently participate in a health plan that’s HSA eligible. The benefits of an HSA is the ability to accumulate funds year-over-year and the potential triple tax advantages3 can give you an edge, because they help you save on taxes along the way.

Why an HSA?

You may be wondering, shouldn’t I just save more in other traditional retirement vehicles, such as a workplace retirement plan? The answer is yes; you should always save as much as you can for retirement in a tax-advantaged vehicle. But when it comes to covering health care expenses in retirement, the HSA is a particularly good fit:

  • An HSA offers even greater tax benefits than other types of retirement plans. When paying for health care expenses—you can use money from your HSA tax-free; when you use money from traditional retirement vehicles, those distributions are typically subject to tax.
  • Participating in an High Deductible Health Plan (HDHP) can save you money on health care premiums compared to other health plans. Those extra dollars can be banked in your HSA.
  • A well-managed HSA is a blend of cash for short-term needs and investments for longer-term needs. If you actively manage and invest your HSA, you improve the chances that your account will grow. For example, you can invest the portion of your HSA that you don’t need for current medical expenses in mutual funds to potentially let your invested balance keep growing tax-free, year over year.
  • An HSA is portable and the money is always yours. You don't lose your HSA If you get a new Job or leave the workforce.. Your HSA can be used now, next year or even when you're retired.
  • Think about it: You can use your tax free withdrawals from your HSA to help you pay for Medicare and long term care premiums – two particularly big expenses to cover.

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The HSA is designed for this when it comes to covering health care expenses in retirement,the HSA is a particularly good fit

Even if you feel you can’t save a lot in your HSA now, a little can go a long way, especially when you factor in the tax benefits.

Get help

Funding health care in retirement is a complex subject, and it’s worth seeking help as you consider your options. Learn as much as you can by reading more articles on this site, and consider talking to a financial advisor. An advisor is specially trained to help you develop a plan to cover all your needs in retirement, including health care expenses.

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Tip : You can use your HSA to pay all types of medicare plans,but cannot use it to pay for Medigap supplemental policies.

1Employee Benefits Research Institute, Issue Brief, no. 549, January 20, 2022.

2Sources: Employee Benefits Research Institute, Issue Brief, no. 549, January 20, 2022. A 65-year-old couple, both with median drug expenses needs $296,000 to have a 90% chance of having enough money to cover health care expenses (excluding long-term care) in retirement. Savings needed for Medigap Premiums, Medicare Part B Premiums, Medicare Part D Premiums and Out-of-Pocket Drug Expenses for Retirement at age 65 in 2021.

3Potential Tax Advantages: You can receive federal income tax-free distributions from your HSA to pay or be reimbursed for qualified medical expenses you incur after you establish the HSA. If you receive distributions for other reasons, the amount you withdraw will be subject to income tax and may be subject to an additional 20% tax, unless an exception applies. Any interest or earnings on the assets in the account are federal income tax-free. You may be able to claim a tax deduction for contributions you, or someone other than your employer, make to your HSA directly (not through payroll deductions). In addition, HSA contributions may reduce your state income taxes in certain states. Certain limits may apply to employees who are considered highly compensated key employees. Bank of America recommends you contact qualified tax or legal counsel before establishing an HSA.