Retirement

Planning for healthcare in retirement – some pros & cons of investment products

By August 2, 2015 No Comments

As you may already know by now, you will have a mandatory expense in retirement known as health coverage, and surprise! – it will be determined by the amount of income you will have in retirement.

In 1993 there were changes to Social Security’s Program Operations Manual System (POMS). A person receiving Social Security Retirement benefits must also accept Medicare Part A, or else face the penalty of having to forfeit all current, future, and even past Social Security benefits.

Granted, Medicare Part A is free if you meet the same 40 quarters definition for Social Security. But Medicare Parts B & D are not free, and they both come with a late penalty for delaying enrollment past age 65. There are also surcharges to the Part B & D premiums for anyone earning “too much” income.

The income test that is used, as defined by Social Security, is “your adjusted gross income plus any tax exempt interest you may have or everything on line 37 and 8b on the IRS form 1040.” The technical term for this income is Modified Adjusted Growth Income, or MAGI.

Some examples of income that are part of MAGI: Wages, Social Security, most Capital Gains, all Dividends, Rental & Pension Income, withdrawals from most retirement savings plans, and even most Annuities.

Unfortunately, certain Medicare premiums and all surcharges due to income, along with any late penalties, are automatically deducted from any Social Security benefit you may receive. So what you think you may be getting in terms of a benefit may not actually be what you ultimately receive.

Below is a list of some of the popular retirement options, and how they may or may not affect your future health costs.

Please note that it is strongly advised that you seek advice from a financial professional who understands these rules before investing any of your hard earned money into any particular long term financial vehicles.

Traditional Employer Retirement Plans:

What are they:  According to Investopedia, “A qualified plan established by employers to which eligible employees may make salary deferral (salary reduction) contributions on a post-tax and/or pretax basis. Employers offering a 401(k) plan may make matching or non-elective contributions to the plan on behalf of eligible employees and may also add a profit-sharing feature to the plan”.

They may include:  401(k) Plans, 403(b) Plans, 457 Plans, Simple and SEP IRA’s, Keogh Accounts, Money Purchase Plans, Profit Sharing, Target Benefit Plans*, Cash Balance Plans and Payroll Deduction Plans.

Pros:

  • Grows tax deferred, which offers the potential for your investments to compound the rate of return.
  • Pre-taxed contributions may lower your current tax obligations.
  • Employers may make contributions into your account as well, or match your investment up to a certain point. That means ‘free’ money to invest.
  • Choice  – various investment options. Some plans allow outside 3rd party management.  you may be able to use mutual funds or a variable annuity as investment vehicles.
  • Portability when you change employers.

Cons:

  • Not every employer offers a plan.
  • Not every employer, especially those offering a 403(b), will match your contribution at any percentage.
  • All monies withdrawn are considered to be a taxable event by the IRS, and any monies withdrawn before age 59 ½ are subject to an extra 10% penalty tax.
  • All withdrawals will be used against you by Medicare when determining your Part B & D premiums.
  • These accounts (except for Roths) are subject to the Required Distribution Amount (RMD) once you reach the age of 70½, and all monies will be counted as ordinary income.

Roth Employer Retirement Plans:

What are they:  According to Investopedia Modeled after the Roth IRA, the Roth 401(k) gives investors the opportunity to fund their accounts with after-tax money. Investors will receive no tax deduction on contributions to a Roth 401(k), but they will owe no taxes on qualified distributions.

They may include:  401(k) Plans, 403(b) Plans, 457 Plans, Simple and SEP IRA’s, Keogh Accounts, Money Purchase Plans, Profit Sharing, Target Benefit Plans*, Cash Balance Plans and Payroll Deduction Plans.

Pros:

  • Grow tax deferred.
  • Choice – you may be able to use mutual funds or variable annuities as investment vehicles.
  • Not subject to the Required Minimum Distribution (RMD) rules.  Meaning you can allow these accounts to continue grow in retirement.
  • Distributions (after qualifications of a beneficiary being at least  59½ years old and owning the account  for more than 5 years) are received tax free.
  • Distributions after qualifications are met are not recognized by Medicare IRMAA’s determination. This allows for a retiree to generate a stream of revenue that will not influence the possibility of increasing health costs.

Cons:

  • Not every employer offers a plan. According to recent reports from Fidelity, less than 46% of all companies offered a Roth and for those that did less than 6% of employees opted to use them.
  • Not every employer, especially those offering a 403(b), will match your contribution at any percentage.

Traditional IRA’s

What are they: According to Investopedia, “An individual retirement account (IRA) that allows individuals to direct pretax income, up to specific annual limits, toward investments that can grow tax-deferred (no capital gains or dividend income is taxed). Individual taxpayers are allowed to contribute 100% of compensation up to a specified maximum dollar amount to their Traditional IRA. Contributions to the Traditional IRA may be tax-deductible depending on the taxpayer’s income, tax-filing status and other factors”.

Pros:

Please note: According to Investopedia, an IRA owner cannot benefit directly from the property in any sense, such as by receiving rental income or living in the property.
Cons:

  • You are limited in the amount that you can invest per year. According to the IRS you can contribute in 2014 up to $5,500 per year.  If you are 50 years old or older, you can invest $6,500 per year.
  • All monies withdrawn are considered to be taxable as ordinary income by the IRS.
  • All withdrawals will be used against you by Medicare when determining your Part B & D premiums.

Roth IRA’s

What are they: According to Investopedia, Roth IRA’s are individual retirement plans that bear many similarities to Traditional IRA’s, but whose contributions are not tax deductible, and whose qualified distributions are tax free.
Pros:

  • Grows tax free.
  • Investments include the same options as Traditional IRA’s.
  • Qualified withdrawals are tax free.
  • Medicare does NOT recognize any withdrawals as income.

Cons:

  • You are limited in the amount that you can invest per year. According to the IRS you can contribute in 2014 up to $5,500 per year. If you are 50 years old or older, you can invest $6,500 per year.
  • If you are earning too much income you cannot participate in a personal Roth IRA:
    • As of 2014 the income limits, according to the IRS are:
      • $129,000 for individuals
      • $191,000 for couples

Annuities

What are they:  Contracts from insurance companies that allow one to use capital to purchase income that may be received now (immediate) or at a later date (deferred).  The contracts may accept only one premium purchase, or they may allow many purchases.  The funds deposited may grow based on several options for crediting the growth.

Pros:

  • Purchase may grow tax deferred over time (deferred annuity).
  • Can have specific and optional “riders” that allow for guarantees like income, a death benefit, long term care and even performance.
  • Certain contracts will guarantee principal against market declines. Others may guarantee an income benefit regardless of investment performance.
  • Joint income options available, along with multi-generational planning options for income.

Cons:

  • Portions of the withdrawals will be used by Medicare when determining your premiums.
  • Guarantees may have a high cost.
  • Potential liquidity issues and surrender charges.

Life Insurance

What is it:  A risk transfer tool that creates liquidity after a person passes away. Typically used to insure against a loss of life. It may also be used for various estate planning, such as paying of debts and obligations, estate maximization, legacy planning, etc.  Cash accumulating insurance contracts, such as Whole Life, Variable Universal Life, Universal Life and Indexed Universal Life, offer cash values that can be accessed to fund expenses or supplement one’s income.
Pros:

  • Protection for heirs after loss of life.
  • Cash value may generally be accessed at all times, whether through withdrawals or policy loans.
  • All cash value may be tax free if accessed via a loan.
  • Income may not be recognized by both the IRS and Medicare.
  • Some plans have riders for long term care, certain illnesses and withdrawals later.
  • Possible guarantees of performance in certain vehicles like Whole Life.
  • Death benefit, if the policy is properly structured, will be tax free to beneficiaries, and the value of the policy may not be part of the decedent’s estate.

Cons:

  • Need to be medically underwritten to be approved.
  • Term policies, while often thought as inexpensive, do not build up cash.
  • May require a larger outlay of premiums to keep the policy afloat in future years.
  • Cash growth may be minor in the early years.
  • Poorly structured policies could be taxable.

Summary

There are plenty of investment vehicles that can be used to help produce income for you in retirement, but unfortunately not all of these income streams are created equal.  Even worse, most income produced from investments may lead to an increase in your healthcare premiums and costs in retirement.

It is important to keep an open mind regarding the need to understand that many traditional retirement planning strategies are no longer the most efficient way to go. The rules of retirement have changed, and you should seek out an advisor or advisory team that understands these changes.

For more information on what to expect in terms of costs for your health coverage in retirement please see our free report at http://www.yourretirementcosts.org/

Dan McGrath

Dan McGrath

Mr. McGrath is a Co-Founder of Healthcare Retirement Planner as well as Jester Financial Technologies. He is a best selling author, "What you don't know about retirement will hurt you" and is a nationally recognized speaker on how health costs impact retirement.