Step 4 of Retirement Success Plan: Health Care Planning

Speaker: Between health insurance premiums, Medicare premiums, and out-of-pocket expenses like prescriptions, copays and deductibles, you’re expected to spend well over $200,000 on healthcare over the course of your retirement, and that doesn’t include the potential for long-term care costs later in life. This is why healthcare planning is step four of the retirement success plan.

The First Four Steps of the Retirement Success Plan

Step one, the allocation. This is how we spread your dollars around various investments according to your willingness to take risk and your capacity to take risk to generate income. Then income planning is step two, tax planning is step three. And healthcare planning here at step four has to be done in this sequence, because really, what healthcare planning is, if you retire prior to 65, it’s actually income and tax planning, and the result of that is what you’ll pay in healthcare costs. I want to go through some of the tools that we use that you can use at home, but also start to look at the bigger picture and how these different decisions impact your overall retirement plan.

The first step in this process is to really identify what choices we have, and then understanding the impact that those choices can make. Some of you will have more choices than others. For example, if you have all of your money inside your retirement account, any time you take money out of that account, you have to pay tax on it. That increases what’s called your modified adjusted gross income, which then determines whether you qualify for a premium tax credit, a subsidy for a healthcare plan, or if you do not. If we save money today by managing where we take distributions from in retirement, how does that impact us in 5 years, in 10 years, in 20 years? Once we have that clear picture of how these decisions can impact you today and into the future, we can really start to discuss the benefits and considerations for going down each path.

Many of you out there, you have a lot of money inside your 401(k) or an IRA. Whenever we take money out, again, those distributions are subject to income tax, there’s nothing we can do about that. Here, we have a longer-term comparison of addressing the tax infestation in your retirement account by doing Roth conversions at a strategic pace over a set number of years. Now, the plan always changes because account values change, the tax laws can change, but from a high-level view, we see we could potentially pay $269,000 in taxes if we address this challenge, versus over here if we follow the conventional wisdom path, we’re looking at about $750,000 in taxes, so this is a substantial long-term challenge.

Time to Strategize

The question now becomes, do we address this first, or do we try to strategically take money from maybe your non-qualified, which is money that’s outside of your retirement account in combination with retirement account withdrawals? Or we defer the retirement account, simply pull from bank savings or other assets that aren’t inside a retirement account. Do we turn social security on? What impact does that have on the tax calculation? This is the average healthcare cost for a couple retiring in this country prior to age 65. It’s about $24,971 for someone that’s retiring. This is a married couple. About $2,000 a month before Medicare, so that’s $24,000 a year. That’s money today that if we do strategically plan for reducing those costs now, we do have to defer the retirement account planning. The question becomes, do we want to save money today, or is it more important to address the longer-term challenge?

That $24,000, that’s the average cost for health insurance premiums and out-of-pocket costs. Now, your situation may be a little bit different, but we sit with thousands of people, and when they retire before 65, that’s a pretty good estimate of what you’re going to be faced with when it comes to cash outlays for healthcare coverage prior to Medicare. From a planning perspective, there are ways that we can keep those health insurance premiums down. We have to be very aware of what’s called our modified adjusted gross income. This is a very important number in the tax code and in retirement planning in general. It impacts many different aspects of the code, but also, it’s calculated differently for various aspects of the code.

For example, when we’re looking at any Medicare premium increases, the calculation for modified adjusted gross income is different than the calculation for premium tax credits for reducing your health insurance costs. Same word, modified adjusted gross income, but it’s calculated two different ways, so we have to understand some of these nuances. We’re going to go through these, but here is just a calculator that we can use. It’s from the Kaiser Foundation. There’s a whole bunch of these online, but I just want to walk through how it works. You can enter your state here– We’re just looking at the US average. Your household income, so $35,000. Is coverage available? No. From your spouse’s job, this is health coverage. Number of people in your family, number of adults 21 to 64, any children? No.

The income number there, that is the modified adjusted gross income. We’re going to get into in just a minute about how you calculate that, but we see here we could qualify if this was our situation. The average benefit is $2,003 per month, so that’s $24,000 a year in a tax credit that will dollar for dollar reduce your health insurance premiums. Now, at the end of the year, because we have to tell the government what we anticipate our income being in advance, if it ends up being different than what we’ve told them, we may get a bill at the end of the year, but also, we may get a refund if it’s actually less, and our subsidy could potentially be more.

Just want to introduce you to this tool. There are a bunch of other tools out there, but in order to properly use this tool, you have to know how to calculate your modified adjusted gross income. This is directly from healthcare.gov. It’s important to note though, that not every state participates in the federal exchange. We just recently had a client we were working with in New York, and even though it’s modeled after the Affordable Care Act legislation, the rules are a bit different, at least we were told that, of how modified adjusted gross income is calculated. It specifically has to do with which deductions you can take to lower your modified adjusted gross income number down.

How to Calculate your Modified Adjusted Gross Income

If your state does participate in the federal exchange, you can go to healthcare.gov. I’m going to show you where to look and what to look for. If your state does not participate, you’re going to have to contact them directly. There should be a website and a number for– some type of hotline for assistance to help figure this out. You can just google healthcare.gov MAGI calculation, that should get you here. Social security– It’s important to understand this, because a lot of times people want to take social security early as soon as they retire, but you have to understand that it increases your modified adjusted gross income for this calculation, and then that could result in you paying more in health insurance costs. So, net, you’re not really receiving any additional benefit by turning social security on, or a reduced benefit.

Social security is either 100% tax-free, 50% tax-free, or 15% tax-free depending on, you guessed it, modified adjusted gross income, but guess what? It’s also a different calculation than what we’ve talked about previously. So, just understand, turning your social security benefit on could impact your qualification for a healthcare subsidy if you’re retiring before 65. Any income, so if a spouse is still working, any self-employment income, any unemployment compensation, social security, these are all of the incomes that go into calculating your total modified adjusted gross income.

Once you’ve calculated your income, an estimated basis for the upcoming year, we now have to take into consideration any deductions. Just below this chart I just showed you, it says, “Can I take deductions from my income?” If we click on that, this page comes up. We can deduct these expenses, we cannot deduct these expenses, so total income minus certain deductions is going to equal your modified adjusted gross income for the purpose of doing this calculation. This calculation, again, is not the same for all aspects of the tax code that depend on MAGI to determine if you qualify or do not for other parts– other benefits.

Alimony, if your divorce was finalized before January 1st, 2019. Educator expenses if you’re a teacher and you pay out-of-pocket, student loan interest, and any health savings account contribution, so you do not have to be working to make a health savings account contribution. That money can go in there on a tax-deductible basis. It grows tax-deferred, and if you take money out for qualified healthcare expenses, it’s 100% tax-free, everything. The HSA is one of the most amazing accounts out there. If you’re not taking advantage of it, it’s something you should definitely look into. Charitable contributions, dependent or childcare expenses, medical expenses, mortgage interest, a lot of property taxes, estate income taxes, tuition costs– A lot of the expenses that you normally would get to deduct to calculate your tax liability, you do not get to deduct when calculating your modified adjusted gross income level.

Okay, now you have a good understanding of how this calculation is made to help determine whether you qualify for a subsidy or not. Because again, let’s keep focused here, we’re trying to reduce the out-of-pocket cost that you pay for your health insurance premiums, but we do have to weigh this decision against the longer-term tax challenges that we have inside the retirement plan. One of the tools that we use here is a tax planning software that allows us, once we’ve received this information from you, we can start to put it in here and then start to play with some of the numbers.

Let’s say we have a dividend portfolio, that step one, the allocation meeting, we’ve decided we wanted a dividend portfolio. IRA distributions– Let’s say we were thinking about doing a $40,000 Roth conversion here. Now, you’ve come in and you’ve taken social security, so you just retired, and the gross social security between two spouses is $46,000. Now we come down here– First, the software is really cool, this is going to show us other opportunities. For example, if one spouse is still working, we can make a Roth IRA contribution because we’re under the limit.

Some other things here, IRA contribution, this is very important because this is one of the tools we can use to help lower your modified adjusted gross income to get a higher subsidy, but really, this is what I’m looking for, modified adjusted gross income for ACA premium tax credit– Okay, comes in at $109,000. Now if we go back to the Kaiser Foundation website, we take this MAGI, enter $109,000, come down here, submit. Okay, so we still qualify for $1,279 or $15,347 per year, so we can still possibly do the Roth conversion. We can have that dividend and interest and still qualify for some type of subsidy here. Now we’re looking at– This is based off the silver plan, the most you have to pay is 8.5% according to the law. Without financial help, your plan would’ve cost about $2,000 a month.

You have other information down here about bronze plans, gold plans, so this is something where you’re going to have to find a specialist who works with these different health insurance plans, but really, you have to make sure that these policies are going to cover whatever needs that you may have. There are certain limits that set the maximum out-of-pocket expenses. This is not our area of expertise, the health insurance marketplace, so you definitely want to find someone who can help you navigate the choices that you have, and make sure they fit you and your medical needs at this stage of life. But strictly from a financial standpoint, we see how we’re starting to now do planning where we’re incorporating the different decisions that you have to make, where you take income from, do you turn social security on, are we doing Roth conversions? And looking at this analysis to determine what your MAGI is, and now, another tool, we can go and plug it in and look to see if we qualify for a subsidy.

An Example With No Roth Conversion

Let’s look at if we didn’t do the Roth conversion. Let’s say– Even if we started social security, if it’s been only a few months, you do have the option of either suspending social security or paying it back, so we could actually reverse this decision. We have a couple of ways of doing that. Let’s say we look at everything, and because social security has a guaranteed increase to it every year that we defer it, let’s say we decide, “You know what? I like that concept, Troy, I don’t want to take social security now.” We start to analyze no social security income, and you say, “You know what? I have these savings where I don’t really need to pull income out,” let’s look at maybe not doing a Roth conversion just to see what that is. We’re still going to have the dividends because we have money invested and we don’t want to let the tax tail necessarily wag the dog, meaning we need to generate income, we have an investment plan, so we’re just gathering information.

We come down here and we see now our modified adjusted gross income is $23,000. We can go back and forth, we can say, “What is the increase to the premiums if we do a $60,000, or a $70,000, or $80,000 conversion?” Either way, we can look at that, come back to the calculator. It should be pretty similar to what it was in the beginning, but just to show you, $23,000, everything else is the same, we hit submit– $2,051, back to $24,000 a year, so maybe we can do another Roth conversion. There’s no real exact right answer here. You can start to see now how it’s kind of gray, because we still have this tax problem long-term to where if we don’t address this, especially right now where we have a much larger opportunity to fill these tax buckets up because of the Trump tax cuts which are going away in 2026, so it’s a balance. We have to make some of these decisions, but I just wanted to show you why step four of the retirement success plan is so important. It’s because these decisions can help put more money in your pocket today.

When we start to look at these choices, I’m always a big proponent of keeping more money in the pocket today because RMDs don’t start on that retirement account until you’re 73, possibly 75, depending on your age. We have more time to take care of that problem where this is a certainty, where if we do these things, let’s say take no money out of the IRA, do not turn social security on, live off the non-qualified or non-IRA accounts, if we can put $2,000 extra per month in your pocket right now, it’s a guaranteed win. I like that, I’m on board with it.

Long-Term Care Planning

The second part of healthcare planning is the long-term care side of things. Many of you have taken care of a parent, or you know someone who has, or possibly you’re going through that right now, and you understand not only the financial burden that that can create, but also the emotional and time burden. So, we have to make a choice. Do we want to self-insure? Do we want to buy what’s called a traditional long-term care insurance policy, or do we want to look at some more permanent options? Once we’ve done those first three steps, we can start to extrapolate out into the future, do a sensitivity analysis to see, okay, best case scenario, most probable or median scenario, and then worst case scenario, and see approximately how much money that we are anticipated to have less.

Here, we have the Genworth Cost of Care Calculator. You can Google this, it’s just Genworth Cost of Care Calculator. Enter your zip code, look at the hourly, daily, monthly rates. We have a little slider where we can look into the future to see what the projected costs are. These are based on median costs, so not the most you can pay, not the least, but kind of right there in the middle. In Houston, currently for home healthcare, $4,500 a month is the median. I slid this out 25 years, it’s estimated to be $9,500 per month.

Now, we have clients right now that are spending $20,000 a month to take care of their parents for home healthcare. Many of you know the personal story that I went through with my grandparents. This was almost 20 years ago. I was right out of college, I took three years to take care of them because my grandfather had two aortic aneurysms. In rural North Carolina, they were being charged $40,000 per month. Two nurses, 12-hour shifts, 24 hours a day, $40,000 per month. These costs are all over the board, but this is a handy calculator to kind of let you know what the median is in your particular area, but please understand, you could also spend a whole lot more.

Now, some people will need care for 30 days, some people will need care for a very long time if it’s something like Alzheimer’s or dementia. You have to take into consideration your personal circumstances, but what I’m trying to get at is we’re just trying to use data to help understand how much we could potentially have to pay in the future if this type of care is important to us, because then we can work that into the financial plan. Once we’ve gathered some of this information and gauged how important to plan for long-term care is to you or your spouse, we can start to use the financial planning software to really look at what are some of the things that we’re afraid of. And one of them for many clients is healthcare and long-term care costs.

Let’s say one spouse at age 80 needs care lasting for three years, and it’s $92,000 a year. Say the second spouse then needs care for two years starting at $92,000. It’s not significant care, but still, inflation– Based on all the planning that we’ve done earlier, having this type of care situation for both spouses reduces the plan from a 99% probability of success to 89%. Then the conversation is, are you comfortable with that? Now, for some plans, it’s going to reduce it a lot more if we’re really looking at your personal circumstances and the potential cost in your area.

Conclusion

Long-term care is the second step when it comes to healthcare planning– The first step for many of you when you’re retiring, and we’re going to knock that down in the first few months of you being a client because it has to do with the income and the overall tax plan. For the long-term care side of things, typically, we’re going to have this conversation within the first 12 months, unless you tell us that this is a priority and we want to move it up in the timeline.

In summary, the first part of healthcare planning is, if you’re retiring before 65, we have to determine where your income is going to come from, because where we take income and how the money is invested determines how much tax you pay. It also determines what’s called your modified adjusted gross income. That MAGI number determines if you qualify for a subsidy to help lower your health insurance premiums. The first part is figuring all that out, putting the pieces of the puzzle together. The second part is longer-term healthcare planning, long-term care. For some of you, this may be very, very valuable information. For others, possibly you make too much money, or you’re past the age of 65 and you don’t have to worry about the first part. Either way, everyone’s financial plan is customized, and these are things that you should be considering whenever you’re building your financial plan for retirement.

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