What you should really believe and prepare for...
The Healthcare Scare
“It is estimated that the average couple will need $285,000 in today's dollars for medical expenses in retirement, excluding long-term care” according to a report by Fidelity.
The fear in most American’s eyes as they read these headlines is sad. There are some things we need to consider though when thinking about healthcare costs. The first, is people are living longer than they were years ago. Simple mathematics tells us that if $285k is being used over a 25-year span, that annual expenditure will be less then the same $285k spent over a 15-year span.
For example, if “Bob & Sue” retire at 65, then both live until 90, they will have expenses for 25 years. Therefore, if “Bob & Sue's” money was not invested, they would spend an average of $11,400 a year for their healthcare expenses ($285k divided by 25 years). What if “Bob & Sue's” money was invested though? Assuming a 5% rate of return compounded annually, and a steady monthly withdrawal adding up to $11,400/year, instead of needing $285k, they would need roughly $165k instead. See the savings withdraw calculator to run your own numbers. Healthcare expenses tend to be higher during the later years of retirement (as mentioned in this NY Times article), so odds are they wouldn’t withdraw $11,400/year straight from the beginning. Instead, they would more likely start at $8k/year, then increase gradually with those last 10 years being the highest. Because of the extra time for his money to compound, the amount the couple would need to have saved for healthcare is even smaller than $165k. Let's say it was $165k though. That is $165k per couple... so cut in half that would really mean the average individual would only need $82,500. Not so daunting now, is it?
According to a study done by Valuepenguin.com, the average cost of health insurance for a 21-year-old is $3,026/year. The average 50-year-old pays 1.786x that cost due to their age, therefore a 50-year-old in an average state would pay $5,404/year and the average 64 year old would pay $8,213/year (Wu, Jonathan 2019), similar to the estimated amount listed above.
Before I became a father, I would hear statistics of the average cost of raising a child. I remember reading the true cost is around $230k from birth through age 17. While looking at this big number, most parents aren't sure how they were able to afford it. For my wife and I, when we were blessed to become parents, even after a $1,600/month daycare expense, our financial situation remained about the same. I’m just suggesting healthcare costs during retirement are similar.
Now, I would never advise someone to save less than they currently are for retirement, but let’s make sure we are not losing sleep for not having the additional $90,000 saved as a couple by 65. There are multiple factors to look at, however. For example, we do want to take into consideration the additional cost of private healthcare until Medicare kicks in if we plan on retiring before 65. Most people are used to a subsidized payment from their employer and get sticker shock when they see the true cost.
The Largest Expense
Let’s talk about the real biggest expense in retirement… taxes. Taxes are something we are used to paying but don’t think a lot about, however by making small adjustments in our financial planning, we can drastically change how long our income lasts in retirement.
The HSA
One type of savings account you can utilize to save on taxes is an Health Savings Account (HSA). We have to make sure we have an HSA qualified high deductible health insurance plan and follow the rules, but an HSA allows us to contribute on a tax-deductible basis (meaning we can lower our taxable income for the year and also potentially lower the percentage of tax we pay on a lower amount if we drop into a lower tax bracket).
There is a limit to how much we can save in these accounts. In 2019, the limit for both employer and employee contributions is $3,500/year for an individual plan, and $7,000/year for a family plan, with an additional “catch up” contribution of $1,000/year if you are age 55 or older (Publication 969 2018). You can use the funds from an HSA at any point tax-free if they are for eligible medical expenses. It is important to be aware of the early withdrawal penalty, for those who use the funds in an HSA before age 65 for non-medical reasons, which is a hefty 20%.
If an individual 50 years old starts an HSA and invests the current year maximum contribution ($291.67/month from 50-55 years old, then $375/month from 55-65 years old), earning a 5% rate of return (compounded annually), they would have $90,471 to use on medical expenses and insurance premiums to pay for policies that cover medical care, tax-free at age 65*. At a 24% federal tax rate, and a 6% state tax rate (30% combined and not including the extra amount of gains from tax-deferrals), this would be equivalent to about $129,244 you would need to save in a normal non-qualified account (90,471/.7). For a married couple maxing out their HSA in the same scenario ($583/month from 50-55 years old then $666.67/month from 55-65 years old), they would have $167,989 at retirement. With the same tax assumptions, not including the extra amount of gains from tax-deferrals, that would be equivalent to about $239,984 they would have needed to save in a non-qualified account without the tax-benefit of the HSA (167,989/.7).
*Click here for a list of qualifying HSA expenses.
The Roth IRA
Another great account to consider having during retirement is a Roth IRA. What is a Roth IRA? It is an account qualifying people can open to save after-tax money in, but ALL growth and distributions are TAX FREE after 59 ½. Some of the other advantages of a Roth IRA include the following:
You are not forced to withdraw your required minimum distributions (RMDs) once you are 70 ½ years old, unlike your traditional IRA or 401(k)
Your Roth IRA withdrawals are not included in the calculation that determines how much social security will be taxed (again unlike your qualifying accounts)
I mention this is an account you have to qualify for in order to contribute. Funding a Roth IRA directly is limited to people under certain income limits. For example in 2019, if you file your taxes as Single, you must earn less than $122,000 to contribute directly to a Roth IRA. If file as married, you must earn less than $193,000 (IRS 2018). (You may make partial contributions if your income is a slightly above those numbers. Refer to your CPA for details).
If your income is already over those limits, you are still in luck. In 2010, the IRS lifted the $100k income cap and now anybody can do what’s called a Roth IRA conversion, or backdoor Roth.
How does this work?
You can convert a partial amount, or the entirety of a traditional IRA into a Roth IRA, then pay the taxes on the amount you converted. Just so you are aware… this will increase your income and you don’t get the tax-deduction you would on a Traditional IRA if your income was low enough that you qualified for one to begin with. As we are at some of the lowest tax rates in history and we don’t know what the future holds… a conversion could make sense for a lot of people. Conversions are generally taxed the lowest when your income is the lowest, therefore timing these with layoffs or retirement can be extremely fruitful. You want to make sure you have enough in your non-qualified accounts to cover the tax bill if you do convert.
Conclusion
Retirement planning encompasses multiple parts. While healthcare plays a large role in our financial future, taxes do as well. Two great accounts to look at setting up before retirement are an HSA and a Roth IRA.
Our proprietary process, The Gratus Flight, relates retirement planning to taking a flight on an airplane. It is important to not only have fuel for the plane, but also a GPS, an experienced Pilot, a well constructed plane, and landing gear that works. With all of those items, we can have a smooth trip. In the same token, we believe we can best create a retirement plan for clients when we have a solid income plan and look at how taxes, healthcare, and legacy planning play their parts. With all of those accounted for, we can work toward a smooth retirement.
You should work with a CPA or tax advisor and a financial advisor to determine if any of the accounts or strategies make sense for you and your family.
Click here to schedule a free initial consultation with our financial advisor.
Justin Marcus
Founder & CEO
Gratus Wealth Management
Justin Marcus studied Finance at Towson University and is an Investment Adviser Representative (IAR) registered in the state of Maryland. He has passed the Series 6, 63, and 65 Securities exams. Justin provides fee-based investment advisory services through AE Wealth Management, a Registered Investment Advisory firm. He also holds life insurance licenses in Maryland, Virginia, and D.C. As a fiduciary, Justin is required to always put his client's needs first.
His proprietary processes, The Gratus Approach and The Gratus Flight, are programs that focus on the key areas of retirement planning: Income, Investments, Taxes, Health Care, and Legacy.
Justin has 11 years of experience in the Financial Services industry prior and started Gratus Wealth Management to focus exclusively on planning for the decumulation process. He believes a strict, retirement-focused niche with a holistic approach serves retirees and upcoming retirees in a better capacity than his prior experience in the industry.
Justin is a Maryland native and currently resides in Bethesda with his beautiful wife and one-year-old son. He most enjoys spending time outdoors with his family and friends.
Fidelity Viewpoints “How to Plan for Rising Health Care Costs.” Fidelity, 1 Apr. 2019, www.fidelity.com/viewpoints/personal-finance/plan-for-rising-health-care-costs.
Wu, Jonathan. “Average Cost Of Health Insurance (2019).” ValuePenguin, ValuePenguin, 9 July 2019, www.valuepenguin.com/average-cost-of-health-insurance.
“Publication 969 (2018), Health Savings Accounts and Other Tax-Favored Health Plans.” Internal Revenue Service, www.irs.gov/publications/p969#en_US_2018_publink1000204046.
IRS (2018) “Amount of Roth IRA Contributions That You Can Make For 2019.” Amount of Roth IRA Contributions That You Can Make For 2019, Internal Revenue Service, www.irs.gov/retirement-plans/amount-of-roth-ira-contributions-that-you-can-make-for-2019.
Investment advisory services offered only by duly registered individuals through AE Wealth Management, LLC (AEWM). AEWM and Gratus Wealth Management are not affiliated companies.
We are an independent firm helping individuals create retirement strategies using a variety of insurance and investment products to custom suit their needs and objectives. This material is intended to provide general information to help you understand basic financial planning strategies and should not be construed as financial advice.
The information contained in this material is believed to be reliable, but accuracy and completeness cannot be guaranteed; it is not intended to be used as the sole basis for financial decisions. If you are unable to access any of the news articles and sources through the links provided in this text, please contact us to request a copy of the desired reference.
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