Social Security is a vital income stream for most retirees. According to the Social Security Administration, 53 percent of married couples and 74 percent of unmarried individuals receive half or more of their income from the program.
What many of these retirees don’t prepare for, however, is the impact of rising health care costs on their benefits. The average 65-year-old couple will pay well over a quarter of a million dollars in Medicare premiums over the course of retirement, and out-of-pocket expenses bring their total health care costs to nearly $400,000.
That’s roughly the same amount the average worker will receive in lifetime inflation-adjusted Social Security benefits. Even with an optimistic projection for a couple who earned equally throughout their lives, health care will consume roughly half of their benefits. Realistically, that figure is closer to 70 percent, and could climb as high as 90 in the next 10 years, according to a HealthView Services report.
While there’s not much to be done about the costs of care – Medicare premiums in particular – clients can use specific strategies to mitigate the effects of those costs on their Social Security income. For middle class and more affluent clients alike, these strategies can help them protect assets, preserve legacies and avoid Medicaid.
Rising costs, lower collection ages
For most retirees, Medicare premiums are the biggest part of the health care pie. The typical 2017 premium is $134 per month, with increased rates for higher earners. Part D prescription coverage rates average between $30 and $40 per month, and supplemental insurance costs an average of $183. Out-of-pocket costs include deductibles, copays and, perhaps most importantly, dental and vision, which aren’t covered by Medigap. Like Social Security itself, inflation will drive these rates up over time.
Despite rising health care costs, most retirees are still collecting Social Security early – and thereby penalizing themselves by up to 25 percent. While only 3 in 10 pre-retirees plan to draw early, the majority of Americans collect before full retirement age – nearly half at age 62. For men, the average collection age actually dropped between 2014 and 2016, meaning more retired men are missing out on the highest payout.
In many cases, poor health prompts people to collect early. According to a 2016 Nationwide Retirement Institute study, 19 percent of recent retirees drew early in order to cover health care costs, and 38 percent said their health problems have kept them from living their ideal retirement. Health issues aside, the vast majority of retirees who drew early did so to pay living expenses, supplement their income and cover the costs of unexpected early retirement.
The result of Social Security dependency in the current healthcare environment?
“Depending on Social Security is no different from depending on a pension,” says Sean Sturges, financial advisor with D.A. Davidson & Co. “For anything that can’t be paid for with your monthly income stream, you’re looking at a Medicaid situation. Even though the net present value of Social Security may be large, you can’t get a lump sum.” Medicaid dependency may also lead to Social Security garnishment, making it even tougher for clients to protect their assets and quality of life.
Another key consideration for early retirees: Even though individuals are eligible for Social Security collection at age 62 1/2, seniors aren’t eligible for Medicare until 65. With rapidly rising rates on the individual market, clients can expect to spend even more on health insurance in those interim years. If there isn’t another income stream to cover these expenses, early collection coupled with a sky-high premium could have a disastrous impact in the critical early years of retirement.
How can clients preserve their benefits and avoid asset depletion and Medicaid dependency?
“We want to create tax-free streams of income before people go on Medicare,” says Rosemary Caligiuri, managing director for United Capital in Langhorne, PA.
The creation of those income streams should start as early as possible, ideally with an HSA during a client’s working years. HSA contributions, growth and withdrawals are all tax-free, and unlike most insurance products, there are no qualifications on when a given health care issue occurred. Clients can save six-figure sums during their healthy years, covering insurance premiums and other expenses out of pocket, then use withdrawals in retirement to cover both Medicare and out-of-pocket expenses.
To minimize means-tested Medicare premiums and taxes, capital gains should also be planned well in advance.
“You can’t wait until the last minute to do tax management,” says Caligiuri. “Start in your 50s. If you realize big gains in your 60s and 70s, your Medicare premiums will go through the roof.”
What about the clients who weren’t so savvy in their 40s and 50s?
“One of the best strategies now is to do a qualified charitable distribution, which directly transfers from your IRA,” says Caligiuri. Only available after age 70 1/2, these distributions can significantly lower a client’s adjusted gross income, thus reducing their Medicare premiums, tax brackets and overall susceptibility to health care costs.
A similarly useful strategy is to leverage a Roth 401(k), since the tax-free distributions will keep a client’s adjusted gross income low. There are no required minimum distributions, either, making it easier to save funds for late retirement, when health care costs are at their highest. Clients can convert funds from a traditional 401(k) early in retirement, paying the taxes at a time when health care costs are lower and assets more plentiful. Those who continue to work work while collecting Social Security can also deposit their benefits directly into a Roth account, maximizing the funds’ use for late-in-life health care expenses.
Still, “The number one line of defense, to the extent that it’s accessible, is ensuring you have adequate Medicare supplement coverage and drug coverage,” says Sturges.
Medigap costs significantly more than Medicare Advantage, but other than long term care, dental and vision, it fills most of the Part B coverage gaps.
Becoming a resource
Social Security and Medicare are critical considerations for every retiree, and making the most of each is essential to maximizing retirement income and preserving assets.
“It’s not what you earn, but what you keep that counts, and you have to tweak your clients’ portfolios for maximum effect,” says Caligiuri.
To that end, it’s important for any advisor working with retirees to educate themselves, partner with specialists or refer out.
“Anytime you can find a solution for a client, it only bolsters your role as the trusted advisor,” says Sturges. “As long as a client has a positive experience with the referral, you still helped them solve that problem.”