Retirement health care costs are on the rise, yet some financial advisers and their clients still have not begun to integrate a major factor of those expenses — Medicare — into their plans.
And those oversights can be costly.
Drew Grider, president of the Retirement Network, learned this lesson just in time, when a 67-year-old client scheduled surgery just days after his planned retirement. Before his client stopped working, Mr. Grider checked to make sure there was no lapse in health insurance coverage.
It turned out that the client had received incorrect information from his employer's insurer.
An insurance company representative had told the client that, although he was over 65, he did not need to sign up for Medicare immediately. Instead, the rep said, he could extend his employer-provided health insurance for up to 18 months under the Consolidated Omnibus Budget Resolution Act, or COBRA, to ensure his spouse and children would continue to be covered.
But that was just part of the picture. Mr. Grider consulted with Kathryn Votava, president of Goodcare.com, who discovered a provision buried deep in the company's health insurance policy materials that specified Medicare would automatically become the primary insurer for anyone who retired and who was at least 65 years old.
Translation: Without Medicare coverage, the client would have been on the hook for 80% of the surgery and related medical expenses, and his secondary insurer would be liable only for the remaining 20% of the costs.
The solution was to extend the client's employment by one month to ensure the employer-provided insurance plan covered the surgery and related costs.
Myths and misconceptions about Medicare persist, even as the stakes for making the right decisions around coverage are high. As clients approach 65, they need not only to make sometimes-tricky choices about their health care coverage but also to consider how Medicare enrollment could affect how much they pay for care and manage investments such as health savings accounts.
While many clients mistakenly believe that Medicare will cover the majority of their retirement health care costs, Medicare really only covers about half of a typical retiree's health care costs, according to Ron Mastrogiovanni, founder and chief executive of HealthView Services.
On top of that, the inflation rate for basic health care is 5% to 7% annually — three to four times as high as Social Security's last cost-of-living adjustment of 1.7%, Mr. Mastrogiovanni noted.
“Many retirement plans are failing to take into account a cost so big that it may one day exceed the Social Security benefits that families are relying on for retirement,” he said.
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MEDICARE ABCs (AND D)
Like so many government programs, Medicare has a lot of moving parts. In this case, it's Parts A, B, C and D.
Medicare Part A covers hospitalization and is free. Even if clients continue to work past 65, most sign up for Medicare A. But if they do, they can no longer contribute to a health savings account.
Medicare Part B covers doctors' visits and outpatient services and costs most retirees $104.90 per month in 2014. It is expected to remain at this level in 2015. Part B premiums are usually deducted from monthly Social Security benefits, or can be paid directly if a person is not yet collecting Social Security. But if a client's modified adjusted gross income — which includes tax-free interest — exceeds $85,000 per year if they are single or $170,000 if they are married, they pay more.
These are cliff brackets, so by going over the limit by just $1, the client is going to pay the higher premium. The income is based on the latest tax return. So a person's 2012 tax return filed in 2013 is the basis for the Medicare premiums paid in 2014. These brackets are not adjusted for inflation, meaning more retirees could drift into the higher premium brackets each year.
Most people who chose traditional Medicare (Parts A and B) also purchase a supplemental insurance policy, known as Medigap, to fill in the gaps of Medicare coverage such as deductibles and co-payments, which have no annual limit.
Alternatively, some people prefer to combine Medicare Parts A and B and supplemental coverage into a single policy known as a Medicare Advantage plan or Medicare Part C. These are privately managed plans and can offer lower premiums or additional benefits — such as vision or dental coverage, or gym memberships — that traditional Medicare doesn't include. But Medicare Advantage plans also limit services to network providers.
To cover prescription drug costs in retirement, clients can purchase Medicare Part D coverage to add to Part A, Part B and Medigap coverage or as part of a Medicare Advantage plan. The cost of an optional Medicare D prescription drug plan varies but averages about $33 per month in 2014. Costs are expected to rise slightly in 2015.
High-income retirees also pay a surcharge for Medicare Part D based on the same income brackets that apply to Medicare Part B. Surcharges for prescription drug plans range from $12.10 to $69.30 per month in 2014, on top of basic plan premiums. Late penalties apply for delayed enrollment.
FINANCIAL PLANNING TACTICS
Medicare doesn't count a handful of investment products as income. They include distributions from HSAs, Roth IRAs and Roth 401(k) plans; proceeds from a reverse mortgage; income and loans from cash-value life insurance; and certain distributions from annuities in nonqualified accounts.
But without moving at least some retirement assets from the taxable to the tax-free column via Roth conversions or other means, clients and their advisers are going to be in for a rude awakening in 2018, according to Dan McGrath, author of “What You Don't Know About Retirement Will Hurt You!” (People Tested Books, 2013) and head of Jester Financial Technologies.
The oldest baby boomers turn 70 1/2 in 2016, he notes, triggering required minimum distributions from their retirement accounts and possibly boosting their taxable income.
Two years later, that higher income could trigger higher Medicare premiums that could go on indefinitely. And when one spouse dies, the inherited assets could keep taxable income high as the surviving spouse slips into the lower Medicare income bracket used for single taxpayers.
“The traditional financial plan for income in retirement is going to be used against people when they retire,” said Mr. McGrath.
Then there's planning for health savings accounts. These accounts offer a triple tax break: contributions are tax deductible, balances grow tax-deferred and distributions are tax-free when used to pay for medical expenses. To contribute to an HSA, you also must be enrolled in a high-deductible health insurance plan.
Unlike use-it-or-lose-it flexible spending accounts, HSAs allow account holders to stockpile funds. And once account holders turn 65, they can spend the funds on nonmedical expenses without incurring the usual 20% penalty. However, HSA distributions used for nonmedical costs are taxable.
But something else happens when you turn 65. If you enroll in Medicare, you can no longer contribute to an HSA. And depending on the size of your company's health insurance plan, you may not have a choice about when to enroll in Medicare.
Normally, you can delay en-rolling in Medicare if you have group health insurance coverage from your current employer or your spouse's current employer. But to avoid permanent late enrollment penalties, the group health insurance plan must have 20 or more members. If you work for a small business with 19 or fewer insured employees or are self-employed, you must enroll in Medicare.
Ignore the rules and you'll face costly consequences. If you do not have credible group health insurance coverage and you fail to enroll in Medicare during the initial seven-month period — which begins three months before your 65th birthday, includes your birthday month and extends three months beyond your birthday — you will have to wait until the next Medicare general enrollment period to sign up.
Medicare general enrollment is from Jan. 1 through March 31 each year for coverage beginning July 1, meaning you may be uninsured for a long time. Plus, your Medicare B premiums will be permanently increased by 10% for every 12-month period you did not enroll in Medicare when you were eligible.
Once your qualified group health insurance coverage ends, you have eight months to take advantage of a special enrollment period to sign up for Medicare. Even if you take advantage of COBRA to extend your employer-provided health insurance by up to 18 months, you still have only eight months to sign up for Medicare after your group insurance ends.
“As we are seeing more and more folks working beyond 65, it makes for some dicey choices, and people are often misadvised,” Ms. Votava said.
CALLING IN THE EXPERTS
Some advisers are helping clients sort through Medicare issues by bringing in expert help.
Russ Weiss, a financial planner with Marshall Financial Group, said his firm contacts clients three months before their 65th birthday and refers them to insurance specialists who are licensed to sell Medigap policies.
For the past several years, Dave Caruso, founding chairman and managing director of Coastal Capital Group, has worked with Ms. Votava to help clients sort through their Medicare options, select appropriate supplemental Medigap policies and estimate potential health care costs in retirement.
Advisers who have added these services have already seen results.
Mr. Grider, who helped rectify his client's health care coverage before surgery, said the experience turned what had been one of his toughest clients into a big teddy bear, and the advisers in his firm learned an important lesson.