When planning for retirement, most people can accurately gauge the savings they will need to maintain the standard of living they desire. With the help of a certified financial planner, they can also develop a solid plan to invest their retirement savings for favorable returns and optimized tax benefits. Predicting and managing the costs associated with long-term health care, however, is not as straightforward.
Daniel Czulno
A sound strategy for retirement must address not only retirement and tax planning but also medical planning as well, said Daniel Czulno, a certified financial planner and investment advisor with Joule Financial. “An important piece of a financial planner’s job is to work with clients to navigate how these different goals can both complement and compete with one another,” he said.
According to an annual study by Fidelity, a 65-year-old couple can expect to spend $285,000 on health care during their retirement, including premiums but not long-term care, which can raise costs significantly higher, said Josh Ackerman, a financial planner with Context Financial. While couples often spend more money on vacations and entertainment soon after retirement, that spending typically drops off and is replaced by medical expenditures as they age and travel for one or both becomes more difficult, he said.
CHRIS RADCLIFFE
Josh Ackerman
“This has led us to encourage our clients to do the trips, have the experiences now,” Ackerman said. “There are no guarantees.”
While soon-to-be retirees often underestimate their future medical needs and costs, Ackerman said clients whose own parents need or have needed care are often most open to the discussion.
“Some folks come in with an ‘it can’t happen to me’ attitude, and they may be right,” Ackerman said. “The ones that have been taking care of Mom for the last three years are more willing to discuss the potential.”
Preparing for the unexpected
Just as there are varying health care needs in retirement, there is also no “one-size-fits-all” solution for saving, Czulno said. For some clients, the best option for insuring against future costs may be a long term care policy, while others may need to use their assets or rely on family or other financial sources of support.
When developing a health planning strategy, one should also expect the cost of their future care to increase significantly.
“Health care costs will certainly continue to rise faster than many other areas of the economy as patients continue to demand the best care available for a wide range of conditions and diseases,” Czulno said. “Having access to the latest medical advances for many of these conditions, as well as simple increasing life expectancy in each generation, is a recipe for costs to go higher.
“Clients will need to approach their healthcare situation in retirement … based on their own health care history, family history and their tolerance for risk,” he said. “In general, many individuals, especially healthy ones, are influenced by the behavioral concept of recency bias, where they project into the future the situation which they are in now or have been most recently. ... For this reason, working with someone who can provide an objective perspective on risks individuals may face and the need to plan for them down the road can allow people to think through these areas while there is still time to plan for them.”
"In general, many individuals, especially healthy ones, are influenced by the behavioral concept of recency bias, where they project into the future the situation which they are in now or have been most recently." —Daniel Czulno, Joule Financial
For clients considering potential needs for long-term care or assisted living arrangements, having a plan is critical. According to an annual study released by Genworth, the cost of in-home skilled care in Kentucky is estimated at roughly $45,000 per year, while a private room in a nursing home costs roughly $90,000 annually, on average.
“We often tell clients that they don’t necessarily ‘need’ long term care insurance, but they do ‘need’ to have a plan,” Ackerman said. “Some clients have the means to designate some portion of their assets as the long-term care account and others choose some amount of insurance to defray some of the cost. It’s a very personal decision and rarely a conversation the couple has had with each other prior to coming in to work with us.”
The HSA option
An attractive option for many people is a high-deductible health insurance plan coupled with a health savings accounts, or HSA.
John McIntosh and Dale Ditto
Certified financial planners John McIntosh and Dale Ditto, who practice at Baird’s Private Wealth Management (formerly Hilliard Lyons), say they often discuss the advantages of HSAs with clients, both as a tax-free means to save for and cover health care costs and as an attractive investment vehicle.
The great thing about HSAs is that they are triple tax free, they said. Money that goes into an HSA account is contributed as pre-tax funds, and those funds can then be invested and grow tax free. The account holder can withdraw funds for qualified medical expenses tax free anytime in the future. After age 65, the funds may also be withdrawn for non-health care related expenses without incurring a penalty. The current deductible threshold for a high-deductible plan is $1,400 for a single insured and $2,800 for a family.
Unlike Flexible Spending Accounts, the funds in an HSA do not have to be spent each year but can be saved, invested and used after retirement for qualified medical expenses and long term care, they said.
Ackerman said an optimal scenario would be a person or family that has the cash flow to fully fund a 401K and still has money available to maximize its annual contributions to an HSA, while paying most, if not all, current-year medical expenses out of pocket while they are still working.
“This means the money contributed to the HSA grows tax free for a potentially long time. The account can be invested in the market just like an IRA, giving the account the benefit of market growth,” Ackerman said. “Most HSA accounts are held in cash, which isn’t wrong per se, but it misses the real potential of the accounts.”
Andrew Hart
Andrew Hart, a financial advisor with Wallace Wealth Management, said clients can balance the use of an HSA for current medical expenses as well as a long-term investment.
“The purpose of an HSA is to offset the health care costs today with tax free money,” Hart said. “I recommend maximizing your contribution and earmarking a portion for retirement health care expenses and a portion for current year expenses. Those that are set aside for retirement expenses, you should consider investing based on the HSA options.”
John Boardman, a certified financial planner and CEO of Ballast, Inc., points to other advantages of this strategy.
John Boardman
“First, it places more decision power in the hands of the insured. Health insurance companies understand this too and appear to be pricing HSA policies [which are required to fund an HSA] more attractively,” Boardman said. “Basically, they want the insured to feel the costs associated with each visit, essentially avoiding unjustified doctor visits.
“One not-often-discussed benefit is the budgeting benefit,” Boardman said. “An employee who defers $7,000 [the 2019 annual maximum] will not see these funds in his or her paycheck and will learn to live on the remaining amount. When high-cost health-related expenses occur, they have the funds set aside to pay for them. For those really serious about leveraging the power of the HSA, they max out each year but use other funds to pay for medical expenses. This leaves everything in the account to be invested for the future.”
“As of now, the IRS has not implemented a time limit on reimbursements,” Czulno adds.
“This means that, with proper record keeping, an individual could feasibly contribute to an HSA, invest these funds to allow them to grow tax deferred for many years, keep records of all medical expenses and finally take a large lump sum from their HSA at a future date for reimbursement.”
Understanding HRAs
Business owners also have the option of offering a Health Insurance Reimbursement Account, or HRA, which allows them to reimburse employees for medical expenses. The business can contribute up to a maximum amount set by the employer, which can be used to pay for out-of-pocket expenses, copays and the like. “This is a powerful tool to get around putting money into the HSA, only to take it back out the same year,” Ackerman said. “These contributions to the HRA are tax deductible to the business and are not income for the recipient.”
Tim Dunn
Timothy Dunn, a financial advisor with Merrill Lynch Wealth Management, points out several key differences between HRA and HSA accounts. “One important distinction between the two is that, unlike an HSA—which may be funded by the employee, the employer or both—an HRA is only funded by an employer,” Dunn said. “As a result, the employer is permitted to, within certain predefined parameters, establish the details surrounding the manner in which its specific HRA will function; for example, which expenses will be eligible for reimbursement. This generally causes the HRA to place a greater administrative burden on the business. The IRS sets the rules for expenses that qualify for reimbursement from an HSA.
“Generally, HSAs are viewed as a more flexible savings strategy, particularly for an employee,” Dunn said. “For example, if an employee leaves an employer, either to take a position with another firm or to retire, the funds in a HRA may, depending upon the plan rules set by the employer, be available for future qualified expenses incurred by the family, but they cannot be rolled over to an HRA with a new employer. An HSA, being owned and controlled by the employee, is retained by the employee after separating from an employer. This means that the employee may continue to use the HSA funds for medical expenses.”
It’s possible for an employee to contribute to an HSA while also receiving reimbursements through their company’s HRA, in specific cases and under certain conditions. With a retirement HRA, for example, employees with high-deductible insurance plans may contribute to an HSA, and their employers can contribute funds to an HRA, which can be invested, but the money isn’t available until after retirement and can only be used for qualifying medical expenses.
“One of the primary benefits of an HSA is that, after attaining age 65, the employee may withdraw the funds for non-health care related expenses without incurring a penalty,” Ditto said. “While the distribution will be subject to income tax, this type of non-health care related distribution is not possible with an HRA. Although HRA programs have been made more flexible by employers in recent years, the funds are only available for reimbursement of qualified medical expenses. Due to this distinction, the HSA is generally much better suited to serve as a savings vehicle.”