As we all near the one-year mark of being locked up in our homes due to the coronavirus pandemic, I have started to think about how important our health is to everything else we want to do in life. It will not matter how much money you have if your health doesn’t allow you to enjoy it. It is also true that the cost of health is a real cost that we should all plan for under the assumption that being able to pay for whatever comes our way means we don’t have to adjust unprepared.
I think we will see a health care system that, over time, focuses more on preventing problems rather than just curing them once they occur. A little of that mind-set exists now; many of us receive a discount on our health club fees from our health insurance. More of this could be in our future as public policy and insurance companies recognize that incentivizing prevention (e.g., lower premiums for those who can run a nine-minute mile) saves money in the long run.
We are not there yet. Thus, it is important to understand the cost of health care in your financial plan. You might face the up-front cost of monthly Medicare premiums, but there are also some hidden costs that people don’t think about.
When planning for clients’ retirement, we have begun adding a new health care expense line in the spending plan. Deciding your expenses is a personal issue; it can often depend on your health status and medications. Outside of Medicare premiums and medication costs, it is important to consider premiums for long-term care insurance (if you buy it), costs not covered by Medicare (like dentistry), and, toward the end of your life, nursing care (in your home or a facility—particularly if you don’t purchase long-term care insurance).
The second piece to this puzzle is inflation. Currently, in planning with clients, we are assuming that health care costs rise 2.8% faster than normal inflation. Thus, if you think normal inflation will average 3% to 3.5% over the next 30 years, will want to assume your health care costs will rise at 5.8% to 6.3% over the next 30 years. This increase will have a larger impact on how much you need to save (or conversely, how much you can spend on the fun parts of life).
The Taxpayer Certainty and Disaster Relief Act of 2020 made a permanent change to deductible health care expenses. Over the past decade, the amount people could deduct for medical expenses vacillated between 7.5% and 10% of adjusted gross income (AGI), and it was sometimes based on your age. With the permanent change, the number is fixed at 7.5% of AGI, and your age does not matter. From a planning perspective, this change is helpful if you can bunch your medical spending into one year and get above that 7.5% hurdle rate. For example, if you had AGI of $100,000, you would need medical expenses above $7,500 (7.5% of $100,000) to deduct them. Knowing this can lead to a better discussion with your accountant and your doctor.
The Health Savings Account Advantage
Knowing that you should plan for health care, you can ideally start early by using your company-sponsored health care plan. Many employers now offer a health savings account (HSA) tied to a high-deductible insurance policy (and there are HSA options if you’re self-employed). Assuming you are generally healthy, a health savings account can be a great way to prepare for health care spending in retirement.
Think of an HSA as a bank or brokerage account on top of a health care plan. Each year, you contribute money to the account to be used toward the deductible on the insurance policy. But if you don’t need that money, you can save it and even invest it. In 2021, you can save $3,600 as an individual, or $7,200 per family (plus a $1,000 catch-up per person for a married couple if you are over age 55).
The big advantage of HSAs is that you do not have to spend the money within a set period and can instead invest it. HSAs also have a big tax advantage: If you use the money for qualified health care expenses, it comes out tax-free. Since one of your more significant costs in retirement is health care, it makes sense to save as much as you can into your HSA and then use the tax-free money at that point to pay for those expenses.
The planning opportunity here is to pay for nominal health expenses each year out of pocket and let the money in your HSA grow to be used in retirement. Save all your health care receipts as there is no time limit on disbursing money from an HSA. If you were to have an emergency and can produce receipts from years past where you did not take the money out, you could take the money out of the HSA at that point. But assuming that does not happen, getting to retirement with an extra pot of money that has such a tax advantage will add a lot of flexibility.
We often tell clients that it is our job to show them the long-term ramifications of short-term decisions. It is human nature to think about the next day, month, or year, but we rarely think beyond that. Yet when we work out each day, we know we are doing it for both current health and preventative reasons. That is how you need to consider the expense of health care in your financial plan; preparing for the expense is an ounce of prevention.
The opinion of the author is subject to change without notice and must be considered in conjunction with relevant regulation, as well as subsequent changes in the marketplace. Any information from outside resources has been deemed to be reliable but has not necessarily been verified. Each individual has unique circumstances to which this information may or may not be relevant. Under no circumstances will this information constitute an offer to buy or sell and it does not indicate strategy suitability for any particular investor.
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