The Bottom Line | Published in February 2017

Preparing for the Worst

Offsetting health care’s bite on retirement income

By Javier Simon | February 2017
Art by Adam McCauley

Recently, the Centers for Medicare & Medicaid Services (CMS) announced hikes in Medicare Part B premiums and deductibles for 2017.
The deductible will climb to $183, a 10% increase from 2016. About 30% of people not protected by Medicare Part B’s “hold harmless” provision would be looking at premium increases ranging from $134 to $428.60, depending on their income in 2015. Those affected will include new enrollees, those not receiving Social Security, and higher-income beneficiaries.
Because the 2017 Social Security cost-of-living adjustment (COLA) is 0.3%, all other beneficiaries will see premiums rise to $109 this year, compared with $104.90 last year. Such changes to health care costs may affect retirement nest eggs in ways that savers have not anticipated.
Many experts agree that heath care prices will not be reversed any time soon, making it even more important for people to plan ahead. “Next year, we expect to see an increase of a little over 22% for Medicare Part B,” says Ron Mastrogiovanni, president of HealthView Services (HVS), a provider of software that projects health care costs, in Danvers, Massachusetts.
The firm’s research indicates that health care inflation, including for Part B, is expected to grow 6% annually for the next 10 years. These rising costs highlight the need for plan sponsors and their advisers to relay to participants the importance of anticipating health care expenses in retirement.
Encourage Participant Action

There are strategies that plan providers and advisers can pursue to raise awareness and encourage participants to take action, Mastrogiovanni says. First, he says, it is important to communicate to investors that Medicare costs vary immensely according to income.
“Make sure the investments you’ll be generating income from in retirement don’t fall under MAGI [modified adjusted gross income],” Mastrogiovanni advises. “That’s how Medicare determines the income bracket you’re in and what you’ll be paying.”
He notes that someone retiring with income of $85,000 or less can expect to pay $183,360 for health care in retirement; meanwhile, someone with an income of between $85,001 and $107,000 can expect to pay $250,407—a 37% increase. Those making more than $214,000 can expect a 204% increase, to $557,066.
Medicare surcharges also apply to beneficiaries with retirement incomes exceeding $85,000.
To offset these regulatory burdens, Mastrogiovanni says, plan sponsors and advisers can educate participants about different investment vehicles that might reduce tax burdens and move the participants into a lower income bracket once retired or turning 65. These include Roth 401(k) plans, health savings accounts (HSAs) and lifetime insurance policies.
Generally speaking, these products offer various tax advantages. For example, Roth 401(k) drawdowns will not be considered taxable income. So they will not affect an investor’s MAGI or push the individual into a higher income bracket as far as CMS is concerned. HSAs offer a “triple-tax” benefit.
“If you take advantage of a universal life insurance policy and you utilize the assets that are invested in that policy in retirement as a portion of your income, it doesn’t get means tested; so, you don’t pay a surcharge,” Mastrogiovanni explains. “Those are three major products that most advisers in the country can advise their clients on. Today, we’re not just talking asset allocation but the right product mix.”
While not all investors have access to an employer-sponsored Roth 401(k) or an HSA, some vehicles such as Roth individual retirement accounts (IRAs) may offer similar benefits.
“People need to look at not only savings but how they save,” says Mastrogiovanni. “It can significantly change what they are paying for health care.”
Cathy Weatherford, CEO of the Insured Retirement Institute (IRI) in Washington, D.C., echoes this view. When asked what plan sponsors and advisers can do to help participants address rising health care costs, she says increasing people’s awareness and helping them develop a strategy should be the top priorities.
She also says participants can benefit from “shopping smart” for the right products, with the help of plan sponsors and advisers.
This is increasingly important, as, Weatherford points out, IRI research suggests an alarming number of people undersave for health care expenses in retirement. She notes that retirement income calculators among other tools can help determine future health care expenses based on factors such as age, life expectancy, health conditions and even demographics.
However, it should be kept in mind that this technology is only as useful as the information being fed into it. One widely used strategy, when it comes to retirement saving, is aiming for the right income-replacement ratio (IRR). In a report, HVS points out that this number can be misleading, as it sometimes neglects to account for life expectancy, unexpected out-of-pocket costs and income-based surcharges. Moreover, Medicare income thresholds are not expected to be adjusted for inflation.
Another thing to relay to participants is that health care costs vary greatly between what is spent during one’s working years and what will be spent in retirement. “On average, 75% of your premium is paid by your employer in its plan,” Mastrogiovanni points out. “So, we don’t see this as a big hit. But when we retire, we’re going to be paying 100% of that, and we need to be prepared.”
Considering all these factors, plan sponsors and advisers can benefit from helping participants analyze their individual situations to gauge future health care expenses, invest in the right product mix, and navigate the complexities of how MAGI determines Medicare costs.

Assuming average longevity for both sexes, women need to plan for much higher retirement health care expenses than men, according to a report from HealthView Services (HVS), “The High Cost of Living Longer: Women and Retirement Health Care.”
HealthView projects that the average expected future retirement health care premiums for Medicare B, D and supplemental insurance for a healthy woman retiring this year at age 65 and living to 89 will be $235,526 ($153,079 in today’s dollars)—significantly more than the $199,946 ($135,321) for men, who are expected to live to 87. Adding in all out-of-pocket, hearing, vision and dental expenses, women’s total lifetime health care costs will rise to $314,673 ($205,468), compared with $267,395 ($181,625) for men. These numbers assume that modified adjusted gross income (MAGI) in retirement—less than $85,000 or $170,000 for a couple—will not trigger Medicare surcharges.
For a healthy 55-year-old woman living to 89, total health care costs between ages 85 and 89 are projected to be $146,471 excluding long-term care; this approaches twice the $75,200 present expense. For women who live longer, the costs will be even higher.
“While the challenges facing women should not be underestimated, with careful planning and preparation, financial security in retirement is an achievable goal for many,” says Ron Mastrogiovanni of HVS. “It is our intention for the data in this report to serve as a starting point for discussions leading to plans that reflect the future needs of women in retirement.” —Rebecca Moore