Health Care Costs in Retirement: Planning Solutions for Your Clients

Posted by Olivia Zaiya, JD, CFP

November 4, 2015 at 1:30 PM

health care costs in retirementLike many individuals approaching retirement, your clients may need help moving from speculation about potential health care costs in retirement to the reality of these expenses. How can you help close this knowledge gap and improve their financial outcomes? You need to be prepared to have meaningful conversations regarding how to plan for these costs, as well as how to reduce them.

Here, I’ll discuss various health care planning solutions that can help your clients pay for these expenses—and provide you with a valuable revenue opportunity.

Focus on the Goal

Of course, it’s important to understand the variety of potential health care-related costs your clients may face in retirement. And it’s equally vital to have a plan regarding how to pay for them.

Ideally, specific assets should be set aside and appropriate investments made to cover health care liabilities. This fixed portfolio could generate income to pay for the known costs, including Medicare, insurance premiums, and projected out-of-pocket costs. Keep in mind, the goal is to help your clients minimize invading principal and protect retirement income.

The Health Care Portfolio

To reach this goal, start by helping your clients establish a health care portfolio, including the following components:

Income-producing solutions. By earmarking separate investment funds for health care costs, your clients will be encouraged to view health care as a mandatory cost. These investments may include single-premium immediate annuities and fixed annuities to cover insurance premiums and out-of-pocket expenses. Some annuities can provide for unexpected contingencies. For example, long-term care annuities offer clients the opportunity to receive a long-term care benefit on their annuity contract. Some disadvantages, however, include a high up-front investment, rider fees, and having the funds locked in at a comparatively low rate.

Insurance solutions. Did you know that 70 percent of people who reach age 65 will need some form of long-term care over their lifetime? Long-term care insurance (LTCI) can be an important tool in managing this high risk of potentially catastrophic health care costs. It can cover at-home care, adult day care, assisted living facilities, skilled nursing facilities, and hospice care. Plus, LTCI premiums are tax deductible as medical expenses within certain limits. (The amount of the deduction depends on your client’s age at the end of the tax year.) Also, keep in mind that if your client dies before claiming the LTCI benefits, most policies will provide no additional benefits to his or her family.

Another option is a life insurance retirement plan (LIRP). With this strategy, your client can overfund a life insurance policy over a period of years, with the goal of building up the policy’s cash value for use in retirement and the option to add long-term care benefits to the life insurance. Be aware of the disadvantages, though, including the added cost of the life insurance policy itself and that the plan must be carefully managed to ensure that your client is able to reap the potential tax benefits.

Health savings accounts (HSAs). These tax-advantaged medical savings accounts are for eligible clients with high-deductible health plans (HDHPs). For 2015, a qualified HDHP must have a family annual deductible minimum of at least $2,600 ($1,300 for an individual), with the annual out-of-pocket costs limited to $12,900 for family coverage ($6,450 for an individual). After age 65, however, withdrawals from an HSA are not limited to medical expenses, but those withdrawals will be taxed as ordinary income.

One major drawback of this strategy is that HSA contribution limits are relatively low. In 2015, the limit is $6,650 for a family account or $3,350 for an individual account, with an additional catch-up contribution of $1,000 per year for those over age 55. Since there are no rules dictating when HSA funds must be distributed (money can be withdrawn tax-free at any time to pay medical expenses), clients may want to pay out-of-pocket costs from their current income and allow the HSA to grow tax-deferred so that the funds are available to cover health care costs in retirement.

With all of these options to consider, let’s look at a case study to illustrate how your clients might use a health care portfolio.

Case Study

Your clients are a 60-year-old couple who anticipate known health care costs, starting at age 65, of the following:

  • $7,900 per year for Medicare-related premiums
  • $3,100 per year for out-of-pocket costs
  • Potential long-term care expenses of $150,000 each per year

The problem. Their retirement income plan will generate enough income to cover all financial obligations, with the exception of about $500 per month in health care costs. They’re also concerned about long-term care. They have liquid assets of $230,000 in CDs and other savings accounts.

The solutions. The purchase of a joint life deferred fixed annuity will provide an income stream to fund the shortfall. Hypothetically, the couple, at age 60, purchases a deferred annuity for $90,000. This life-only annuity may pay about $500 per month, depending on rates and the company, starting when they are 65 (with no guaranteed payment for an early death to the annuitants).

They use another $50,000 each to purchase linked-benefit long-term care policies. At age 85, they will each have access to a pool of approximately $400,000 in long-term care benefits, as well as a death benefit of approximately $64,000 each in the event one or both do not need long-term care. In addition, each has the option of exercising the return-of-premium feature to receive a refund of $50,000.

In lieu of the long-term care policies, they could use the interest from the CDs and other savings accounts to pay for traditional LTCI. Assuming $140,000 remaining in these investments with a 2.1-percent rate of return, the available money for insurance premiums would be almost $3,000 per year. This could fund a long-term care policy from a reputable carrier with a monthly benefit of around $3,500 for a benefit period of 3 years and 3-percent compound inflation protection.

Other Funding Strategies

Besides establishing a health care portfolio, your clients can also try to reduce the impact of health care costs on their retirement income.

Tax solutions. Medicare premiums are based on your client’s modified adjusted gross income (MAGI): broadly, his or her adjusted gross income plus any tax-exempt interest income. Crossing the first income threshold of $85,000 for an individual or $170,000 for a married couple can increase the costs of Medicare Parts B and D by about 35 percent, and those clients in the highest bracket can pay as much as 200 percent more.

To cut the cost of Medicare, your client could reduce his or her MAGI by maximizing qualified deductions and pulling from tax-free accounts (e.g., a Roth IRA) in retirement. Another strategy to consider is tax-loss harvesting, which can offset gains realized. The goal is to balance gains and losses in the portfolio for the year to reduce MAGI and potentially minimize overall taxes.

If your client’s medical expenses exceed 10 percent of his or her adjusted gross income (7.5 percent for those 65 and older until 2017), those costs are generally deductible. Deductible expenses may include:

  • Insurance premiums
  • Prescription drug costs
  • Dental costs
  • Lab and X-ray fees
  • Glasses and contact lenses
  • Transportation for medical-related activities

Be sure to have your clients keep track of all their medical expenses and work with their CPA to maximize their deductions.

Investment solutions. By modifying investments in a client’s portfolio, you may be able to reduce countable income and move the client into a lower MAGI bracket, thereby decreasing Medicare surcharges.

A Planning Opportunity

Helping clients plan for health care costs in retirement can represent a valuable planning and revenue opportunity. As your practice grows, it’s not enough to rely on servicing existing clients, renewals, and trails for income. Over time, those trails will dry up as your clients take required minimum distributions and divert income and assets for health care costs. Health care planning, including insurance and annuities, can represent a new opportunity—providing revenue while offering a much-needed service to your clients.

What financial concerns do your clients have as they approach retirement? Which strategies do you find most effective in planning for health care costs? Please share your thoughts with us below.

A Guide to Health Care Costs in Retirement

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Topics: Retirement Income Planning

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