Navigating Healthcare Costs in Retirement: A Guide to Planning and Saving

Healthcare costs are one of the most significant and unpredictable expenses retirees face. As you transition from employer-sponsored health insurance to Medicare or the Affordable Care Act (ACA) marketplace plans, understanding how premiums are calculated and how to manage your tax liabilities effectively can make a substantial difference in your retirement planning. If you’re an Arizona retiree looking to plan ahead for healthcare and other retirement expenses, download our free Arizona Retiree Toolkit for tailored insights and strategies.

This blog explores healthcare costs before age 65, Medicare costs, including the Income-Related Monthly Adjustment Amount (IRMAA), and strategies to optimize your healthcare expenses and taxes in retirement.

Healthcare Costs Before Age 65: The Affordable Care Act (ACA)

Before turning 65, many retirees rely on health insurance plans available through the ACA marketplace. Understanding how these costs are calculated is crucial for effective retirement planning.

ACA premiums are calculated based on several factors, including:

• Age: As you age, premiums generally increase.
• Location: Health insurance costs vary significantly by state and region.
• Income: Your modified adjusted gross income (MAGI) affects your eligibility for subsidies that can lower your monthly premiums.

For retirees under 65, keeping your income within certain limits can make you eligible for substantial subsidies. It’s essential to plan withdrawals from retirement accounts carefully to stay within these limits and avoid unexpected premium increases.

Strategies to Minimize ACA Premiums

To optimize ACA costs before age 65:

• Adjust Your Income: Keep your MAGI below 400% of the federal poverty level to qualify for ACA subsidies.
• Consider Roth Conversions Early On: Roth conversions can help manage taxable income, but timing is crucial. Converting smaller amounts over several years before retirement can reduce your taxable income later, keeping ACA premiums lower.
• Utilize Health Savings Accounts (HSAs): Contributing to an HSA can provide a triple tax advantage—contributions are tax-deductible, grow tax-free, and can be withdrawn tax-free for qualified medical expenses.

Transitioning to Medicare at Age 65

At 65, most retirees become eligible for Medicare, which brings a new set of costs and planning considerations. Understanding the basic structure of Medicare and additional costs associated with higher incomes is vital.

Medicare consists of several parts:

• Part A (Hospital Insurance): Generally premium-free if you or your spouse paid Medicare taxes for at least 10 years.
• Part B (Medical Insurance): Covers outpatient care, preventive services, and doctor’s visits. The standard premium for 2024 is $174.70 per month but can be higher depending on your income.
• Part D (Prescription Drug Coverage): Costs vary based on the plan and your prescription needs.

While Medicare provides essential coverage, out-of-pocket expenses such as deductibles, copayments, and coinsurance can add up. It’s important to plan for these expenses and consider Medigap or Medicare Advantage plans for additional coverage.

Medicare IRMAA Costs

The Income-Related Monthly Adjustment Amount (IRMAA) is an additional charge for Medicare Part B and Part D that applies to individuals with higher incomes. Your IRMAA is based on your MAGI from two years prior. For example, your 2024 IRMAA is based on your 2022 income. IRMAA brackets can change yearly, so it’s important to monitor your income and adjust accordingly to avoid unnecessary charges.

Managing Tax Liability to Target Affordable Healthcare Premiums

Effective tax planning can help you control your healthcare premiums both before and after age 65. By strategically managing your income, you can stay within desired premium brackets and minimize out-of-pocket healthcare costs.

Strategies for Managing ACA Premiums

• Make Tax-Efficient Withdrawals: Withdraw from tax-deferred accounts (like a Traditional IRA) only up to the amount that keeps you within a favorable ACA subsidy bracket.
• Use Tax-Loss Harvesting: Offset capital gains with losses to keep MAGI low.
• Take Roth IRA Withdrawals: Withdrawals from Roth IRAs are not included in MAGI, making them an excellent source of tax-free income that won’t affect your ACA premiums.

Strategies for Managing Medicare IRMAA Costs

• Utilize Income Management: Keep your MAGI below the IRMAA thresholds. Use strategies like Roth conversions or Roth withdrawals to lower taxable income.
• Make Qualified Charitable Distributions (QCDs): If you’re over 70½, you can make QCDs from your IRA to satisfy your Required Minimum Distribution (RMD) without increasing your taxable income.
• Time Income Recognition Strategically: Manage the timing of recognizing income from stock sales, property sales, or receiving pensions. Spreading out income over several years can prevent spikes that push you into higher IRMAA brackets.

 Managing Large Liquidity Needs to Optimize Taxes

Significant liquidity needs in retirement—such as buying a second home, helping a child with a large expense, or handling unexpected medical costs—can have tax implications that affect both ACA and Medicare premiums.

Planning for Large Withdrawals

• Strategic Withdrawals: Plan large withdrawals in years when your other income is low to avoid pushing yourself into a higher tax bracket or IRMAA tier.
• Use a Combination of Accounts: Withdraw from a combination of taxable, tax-deferred, and tax-free accounts to manage your overall tax exposure and avoid spikes in MAGI. 

Tax-Advantaged Accounts and Their Role

• Health Savings Accounts (HSAs): Continue to fund and use HSAs for eligible medical expenses. These accounts offer tax-free withdrawals, reducing the need to tap into other taxable accounts.
• Roth IRAs: Withdrawals are tax-free and do not affect your MAGI, making them an ideal source of funds for large, unexpected expenses.

 Future Healthcare Cost Considerations

While we’ve covered many strategies to manage healthcare costs in retirement, it’s essential to consider other potential expenses that could impact your retirement planning, including long-term care and inflation in healthcare costs. 

Planning for Long-Term Care

Long-term care is not covered by Medicare, and costs can be substantial. Consider purchasing long-term care insurance; purchasing insurance early can help cover future expenses. If you have substantial assets, consider earmarking a portion specifically for long-term care needs.

Addressing Healthcare Inflation

Healthcare costs have historically risen faster than inflation. To combat this:

• Regularly Review Your Financial Plan: Adjust your plan as healthcare costs rise to ensure your savings remain sufficient.
• Invest for Growth: Keep a portion of your portfolio in growth-oriented investments to outpace inflation.
• Maintain a Healthy Lifestyle: Preventive care and a healthy lifestyle can help mitigate some healthcare costs.

 Conclusion

Healthcare costs in retirement can be managed with thoughtful planning and strategic decision-making. Understanding the implications of ACA premiums, Medicare costs, IRMAA, and tax strategies can help you maintain control over your retirement finances. By being proactive, you can minimize unexpected healthcare expenses and optimize your income to enjoy a more financially secure retirement.

Remember, consulting with a financial planner to review your specific situation and make tailored recommendations is always a smart move. Preparing for the unexpected can help you navigate the complexities of healthcare in retirement confidently.