Health Care Costs in Retirement: Are You Prepared?

October 11, 2023 Susan Hirshman
Four tips for managing health care costs in retirement.

Even if you've been saving diligently, health care costs can throw a wrench in your retirement plans. A report from the Employee Benefit Research Institute estimates a 65-year-old couple could need as much as $383,000 in savings to have a 90% chance of covering their health care expenses—including premiums, deductibles, prescriptions, and out-of-pocket costs—in retirement. Here are four strategies to consider before you reach retirement age.

1. Make the most of an HSA

If you're enrolled in a high-deductible health care plan (HDHP) that offers a health savings account (HSA), consider using it to sock away extra money for future medical needs. You can make tax-deductible contributions1 of up to $3,850 for individual coverage and $7,750 for a family in 2023 ($4,150 and $8,300 respectively in 2024)—plus an additional $1,000 for those ages 55 and older—which can be invested for potential growth.

Plus, earnings grow tax-free, and withdrawals of contributions and earnings are tax- and penalty-free when used for qualified health care expenses, including Medicare and long-term care (LTC) insurance premiums. And once you reach age 65, withdrawals from an HSA can be used for any purpose without penalty, although ordinary income taxes will apply to funds used for nonmedical expenses.

2. Enroll in Medicare at the right time

Most near-retirees know Medicare becomes available at age 65, but fewer realize there's a permanent penalty for missing the initial enrollment period (IEP). Your IEP is a seven-month span, including the three months before, the month of, and the three months following your 65th birthday. If you fail to apply during your IEP for Medicare Part B—which covers most everyday (outpatient) medical expenses—your monthly Part B premiums could go up 10% for every 12-month period you go without coverage. There's also a 1% penalty per month for each month you delay enrolling in Part D prescription drug coverage (see "The ABCDs of Medicare").

If you begin collecting Social Security before your 65th birthday, you'll automatically be enrolled in Part A (which covers hospital stays and is generally premium-free) and Part B. But if you plan on waiting to collect Social Security, be sure to apply for Medicare as soon as you're eligible.

Be aware that Medicare coverage can be affected if you or your spouse is still working and enrolled in an employer's health care plan. For example, you may be able to delay signing up for Part B without penalty until workplace coverage ends. You could enroll for Part A while being covered by an employer plan—generally, you'll have no premium costs, and Medicare will pay secondary to your group health care plan for hospitalization. However, once you enroll in Medicare, you can no longer contribute to an HSA, so if your plan is to stay with your group health insurance and to keep contributing to an HSA after age 65, you may want to postpone enrolling in Part A.

Once you or your spouse no longer has employer-sponsored health insurance, you'll have eight months to sign up for Medicare during a special enrollment period (SEP) to avoid penalties.

The ABCDs of Medicare

You can avoid paying penalties by signing up for Original Medicare (Parts A and B) during your IEP or SEP, but more importantly, you can curb runaway Medicare expenses by purchasing Medicare Advantage (Part C) or Medigap plus Part D. Learn the pros and cons of each option.

You can avoid paying penalties by signing up for Original Medicare (Parts A and B) during your IEP or SEP, but more importantly, you can curb runaway Medicare expenses by purchasing Medicare Advantage (Part C) or Medigap plus Part D. Learn the pros and cons of each option.

3. Reduce your modified adjusted gross income

Medicare premiums are also affected by your modified adjusted gross income (MAGI). Relatively higher-earning retirees may be subject to Medicare's Income-Related Monthly Adjustment Amount (IRMAA), which is a surcharge on the monthly premiums for Parts B and D if your MAGI from two years prior exceeds $97,000 ($194,000 for married couples filing jointly). The differences in premiums for Part B, in particular, can be steep, so taking steps to reduce your MAGI could lower your medical costs as well.

A premium on premiums

A single filer making just $23,000 more than the income limit for the standard Part B premium could see their monthly payments increase by 100%.

2021 income, single 2021 income, married filing jointly Part B premium Part D premium
$97,000 or less $194,000 or less $164.90 Plan premium (varies by provider)
$97,001 to $123,000 $194,001 to $246,000 $230.80 Plan premium + $12.20
$123,001 to $153,000 $246,001 to $306,000 $329.70 Plan premium + $31.50
$153,001 to $183,000 $306,001 to $366,000 $428.60 Plan premium + $50.70
$183,001 to $499,999 $366,001 to $749,999 $527.50 Plan premium + $70.00
$500,000 or more $750,000 or more $560.50 Plan premium + $76.40

If most of your retirement savings are in tax-deferred accounts that are subject to taxable required minimum distributions (RMDs), which will increase your MAGI when taken, you may want to consider converting some of those funds to a Roth IRA—which offers tax-free withdrawals once you reach age 59½, provided you have held the account for five years. You'll have to pay taxes on the converted amount in the year of the conversion, but Roth IRAs are not subject to RMDs, helping you to better manage your MAGI  in retirement.

Bear in mind the two-year look-back rule when you evaluate the timing of the conversion. If your income from two years ago is higher than your current MAGI and you experience a life-changing event, including retirement, you can apply for an exception to your reduce your Part B and/or D premiums using Social Security Form SSA-44.

Another option is to contribute after-tax dollars to a Roth 401(k), if offered by your employer. Currently, Roth 401(k)s are subject to RMDs (albeit tax-free) starting at age 73, but SECURE 2.0 Act does away with Roth RMDs starting in 2024.

If you must take RMDs, you can take a qualified charitable distribution (QCD) to help reduce your MAGI. With a QCD, you can donate up to $100,000 to a qualified charity directly from your retirement account, which could satisfy all or part of your RMD. (Under SECURE 2.0 Act, the $100,000 limit will be indexed for inflation for tax years after 2023.) Although you can't deduct a QCD as a charitable contribution, the withdrawal won't count as taxable income.

4. Plan for long-term care

Long-term care covers the costs of activities of daily living and can be a significant risk to your financial situation in retirement without careful planning. Long-term care insurance can seem costly—annual premiums with 3% growth for a healthy 60-year-old average $3,525 for males and $4,300 for females—but with the average annual cost of a private room in a nursing home at nearly $108,405, it may be more expensive not to have it. Generally speaking, the most cost-effective time to buy is in your 50s to early 60s, and premiums may be tax-deductible if your overall medical expenses exceed 7.5% of your income. A financial planner can help you strategize ways to structure insurance to dampen the risk of future long-term care costs as well as discuss alternatives.

1HSA contributions are exempt from federal income tax, as well as state income tax in all states except California or New Jersey. Distributions used for nonqualified medical expenses are subject to ordinary income tax and, for those under age 65, are subject to a 20% penalty.

Learn more about health care planning.

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The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.

All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third-party providers is obtained from what are considered reliable sources. However, its accuracy, completeness, or reliability cannot be guaranteed.

Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.

Investing involves risk, including loss of principal.

Roth IRA conversions require a 5-year holding period before earnings can be withdrawn tax free and subsequent conversions will require their own 5-year holding period. In addition, earnings distributions prior to age 59½ are subject to an early withdrawal penalty.

Earnings on Roth 401(k) contributions are eligible for tax-free treatment as long as the distribution occurs at least five years after the year you made your first Roth 401(k) contribution and you have reached age 59½, have become disabled, or have died.