How to Build a Health Insurance Plan for Retirement

If you’re like most retired people, you and your partner will spend $285,000 for medical expenses in today’s dollars over the course of your retirement, says Fidelity Investments. And that doesn’t include the costs of long-term care, such as assisted living or a nursing home.

To best prepare for healthcare costs in the future, begin by taking certain steps while you’re still working. For example, the Health Savings Account, or HSA, should be a critical part of your overall retirement plan.

And don’t think all your medical costs will go away after you hit the magical age of 65 and qualify for Medicare. Fidelity found that 15 percent of retirees’ annual budgets is consumed by healthcare costs, including your Medicare premiums and costs that aren’t covered by Medicare. Most retirees also need to buy additional medical insurance.

The best way to make sure healthcare costs don’t crush you is to prepare for them. The problem is that forecasting how much you’ll spend on healthcare in the future isn’t easy. Or is it? Fidelity offers a nifty online tool that will estimate your healthcare costs. You’ll step through a number of estimates, shown in the following figure, to arrive at a reasonable guess of what you might expect to spend in retirement on medical care.

Unlock the health savings account

One of the best ways to prepare for your medical costs in retirement involves taking smart steps while you’re still working. You might not think much of medical costs as an employee because your employer is picking up much of the tab.

Annual healthcare premiums hit $20,576 in 2019 for a family, up 5 percent from 2018, says Kaiser. And of that amount, workers are generally responsible for paying $6,015. That’s just the insurance premiums. You'll also incur out-of-pocket costs, such as deductibles, ranging from $800 to $5,000 a year.

What’s the solution? A fairly new innovation in medical savings that you can take advantage of while you’re still working is the health savings account, or HSA. An HSA is a unique account into which you can put tax-free dollars, as long as you’re in a high-deductible health plan. HSA are usually offered to you by your employer if you're eligible.

If you’re looking to reduce taxes, you’ll be hard-pressed to beat the HSA. You get triple-tax benefits at the federal level. You put in money tax-free, the money accumulates and grows tax-free, and then you can take the money out tax-free as long as you use it for medical costs. Most states extend tax breaks on contributions, growth, and withdrawals, too. But California and New York, for example, don’t allow state tax-free HSA contributions. Also, state tax deductions don't exist in states that don't have income tax. Be sure to check your state’s HSA tax rules. Even so, you won’t find a better federal tax-shielded account that’s so widely available.

Given the HSA’s superior tax status, if you’re still working and can swing it, you should put as much money in one as you can afford. If you can’t max out both your 401(k) and your HSA, you might put in enough in your 401(k) to get the most from your employer match. And with any money left over, you can contribute to your HSA.

Seeing if you're eligible for HSA

If you want an HSA, you must be enrolled in a high-deductible health insurance plan, or HDHP. The definition of an HDHP changes periodically; for 2020, it’s a plan with a deductible of at least $1,400 for an individual or $2,800 for a family. A deductible is the portion of medical costs that are your responsibility before insurance will pay. You can look up what defines an HDHP plan.

When you’re signing up for a medical plan at work and would like to fund an HSA, look for a designation such as HSA eligible. And don’t confuse the HSA with the flexible spending account (FSA). With an FSA, you must use up the money in a 12-month period; HSA funds can remain until you use them.

Understanding the limits of HSAs

Like most tax-shielded accounts, the Internal Revenue Service limits how much you can put into an HSA. The contribution limits change annually and are lower than you’ll find for retirement accounts such as 401(k)s, but they 're high enough to add up over time. The HSA contribution limits for 2019 and 2020 are shown in the following table.

www.investors.com/etfs-and-funds/personal-finance/hsa-contribution-limits-hsa-rules/ and https://blog.healthequity.com/hsa-contribution-limits

Keep in mind, though, that after you enroll in Medicare, you can no longer put money in an HSA.

Using HSA money

The money you put in your HSA can be invested much like your funds in an IRA. The money grows tax-deferred, shielding you from tax hits from dividends generated by your investments or capital gains.

Investment options vary based on the HSA provider. A minimum HSA balance is usually required before you may invest in funds or stocks. When you do have enough money to invest, most HSA plans will offer you one of three choices:

• Full robo-advisor: Here you turn the management of the investments completely over to the HSA’s algorithm. The plan will select your investments, usually low-cost index mutual funds, and buy them and rebalance them for you. Fees can be upwards of 1 percent a year.
• Robo guidance: Some HSAs will tell you what they recommend, but you do the buying and selling. The HSA plan will typically recommend a mix of low-cost index funds. You’ll save some money with this approach, with fees up to 0.7 percent a year. But you’ll need to do the transactions and keep the account in balance.
• Self-guided brokerage: With this option, you’re on your own and decide which funds to buy. You'll save a bundle on fees by doing the work yourself and typically pay only the annual fees charged by the funds you choose. However, you can choose from only the funds and investments made available by the HSA provider.

HSA accounts are flexible. You can take money out, tax-free, to pay for medical costs ranging from co-payments to eyeglasses, hearing aids, and other medical equipment. However, the money can't be used to pay for over-the-counter medication unless you get a prescription from a doctor.

While you’re working, consider saving your HSA funds and paying for medical costs out of pocket instead. If you leave your HSA relatively untouched while you work, you can put the account’s tax shield to maximum use over time. So rather than using the $200 to pay for the X-ray, the $200 stays invested and can grow so you’ll have more money when you’re retired.

Money taken out of an HSA for non-medical purposes before you turn 65 is socked with a 20 percent penalty. But wait until after you turn 65, and you pay only income tax on the withdrawal. If you think about it, that’s not so bad. After all, it’s no different from how money is treated when you take it out of a traditional IRA.

To read about more ways to maximize your HSA for preparing for retirement, check out the blog from HSA provider Health Equity.

Opening an HSA

In nearly all instances, if you have a high-deductible plan with your employer, your employer will open your HSA. You can also open your own HSA. And if you had an HSA with a previous employer, you can transfer the money into another HSA account.

If your employer offers an HSA, it’s best to simply use that one. Doing so will make it easier for your employer to make contributions and for you to make tax-free contributions straight from your paycheck.

Keep an eye on any fees charged by an HSA plan. Many charge $2.50 a month unless you keep a minimum deposit of $5,000 or more. That doesn’t sound like much, but given that you’ll likely have your HSA a long time, the small fees add up. If you’re being charged excessive fees, it might be time to choose your own HSA. Investor’s Business Daily ranks the best ones.

Medicare supplemental plans

Three months before turning 65, it’s time to sign up for Medicare. You do this even if you’re not ready to start receiving benefits. You can find all the details about signing up for Medicare benefits.

Many retirees think Medicare takes care of all their medical costs, but that’s far from the truth. You have to pay for your deductibles and co-payments. Need glasses, dental care, and hearing aids? Those aren’t covered. If these costs scare you, think about getting additional coverage. The drawback is the cost.

I am not saying Medicare is worthless. Medicare Part A, which covers trips to the hospital, costs nothing annually if you worked at least 10 years. Medicare Part B, which handles doctor visits, and Part D, which handles prescriptions, are based on your income. Most people pay $136 a month for Part B and $33 a month for Part D. (You pay more if you earn more.)

When you first enroll in Medicare, you can choose between the following:

• Original Medicare: Here you get Medicare Part A and Part B coverage. You can also join a separate Part D plan for drug coverage.
• Medicare Advantage (also called Part C): These plans include Part A, Part B, and Part D coverage and are offered by third-party insurers. You might pay less out of pocket with the Medicare Advantage plan than you would with Original Medicare if the limits are different. Some Medicare Advantage plans cost more if dental and eye coverage are included, too.

If you’re worried about the out-of-pocket costs that Medicare might not cover, you can buy additional Medigap policies. Medigap covers items Medicare doesn’t.

If you think that understanding Medigap could be an entire book, you’re right! The government’s free book on Medigap policies is the de facto and most accurate resource. You can download it for free.

What if you decide you’d like to buy a Medigap plan, also known as a Medicare Supplement or Medicare Supplement Insurance plan? The Government can help you find a plan. Simply enter your zip code, and you’ll see all available Medigap plans. The screen details the plan type, coverage, and cost. You can drill down and get particulars by clicking the Plan Details button, as shown.

Explore the exchanges

If you’re not quite 65 and find yourself without employer-paid healthcare, you’ll need to do some planning. After all, you’d hate to have unexpected medical costs eat away at money you’ve saved and invested as part of your retirement plan.

If you find yourself in this situation, you have a few options, including the following:

• COBRA: COBRA is government-mandated coverage that your employer must offer to you if you leave. COBRA will keep you on the company healthcare plan for at least 18 months (longer in some states). The catch? The employer no longer must make their part of the premium payments. The entire premium payment is your responsibility, and it’s not cheap.

COBRA can be a good option if you leave a job in your early-to-mid 60s and are close to enrolling for Medicare. You’ll have access to the same physician network and your coverage will stay the same. COBRA might make sense also if you’re currently undergoing treatment and don’t want any coverage changes.

• Health insurance through your spouse: It’s common for your spouse’s employer to bar you from being on its health plan while you’re working. But if you’re not working, joining your spouse’s plan is a great option.

Losing your job is usually a qualifying event for you to join the plan. You don’t need to wait until the end of the year’s open enrollment period.

• Affordable Care Act Marketplace Exchange: Major healthcare reforms in 2009 created an option for people who need health insurance. The system is surprisingly straightforward to use, given how long the idea was debated by Congress. First, go to gov to see if you’re eligible to enroll, as shown.

The site will take you to a directory of all major medical insurers who participate in your state’s healthcare exchange. You can also shop for vision and dental plans.

From your state’s exchange site, you can look up what available plans cover and cost. Given the highly personalized nature of healthcare, examine how much you typically spend on medical expenses to help determine the best option.

It pays to take a close look at your typical healthcare spending, so you can match your needs with your plan. Consider a high-deductible plan so you can also open a health savings plan.

Consider long-term care insurance

When you hit your 50s and 60s, you have another insurance decision to make: whether or not to buy long-term care insurance. As mentioned, Medicare does not pay for all your medical costs, and those uncovered costs include nursing homes and other skilled care.

Genworth, an insurance company, estimates that seven out of ten people will need long-term care during their lifetime. And the cost of long-term care is astronomical, as you can see in the following table.

Genworth Financial

Genworth has a tool to help you calculate long-term care costs in your area. Simply go to the website and enter your zip code.

Given these sky-high costs, it’s only natural that pre-retirees or retirees want to hedge their bets. Enter long-term care insurance. With a long-term care insurance plan, you pay a premium, usually in your 50s and 60s, and the insurance company agrees to pick up part of the cost of care if you need it.

Long-term care plans sound reassuring, but they’re not cheap. A single 55-year-old man looking for $200 in long-term coverage every day for up to five years would pay $3,094 a year in premiums. To look up how much a long-term care policy would cost, go to Genworth's calculator. In addition to deciding the number of years of long-term coverage and the amount of daily coverage, you decide whether you want an annual inflation adjustment. Long-term care costs are likely to only increase, so you might want at least a 2 percent annual inflation adjustment so your coverage can keep up somewhat.

You also need to carefully research the financial strength and reputation of the long-term care insurer. Nothing would be worse than to land in a nursing home only to find out that your insurer won’t make the payments or find some reason to not cover your claim. Stick with reputable long-term care providers, such as members of the American Association for Long-Term Care Insurance.