How healthcare costs can eat away your Social Security

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Originally created during the Great Depression as a safety net for workers and their families, Social Security has become a major source of income for many retirees. If you’re in retirement or getting close, chances are good that Social Security is featured prominently in your financial planning.

You may have heard that Social Security funding is in a precarious state. But rising healthcare costs pose an even greater risk.

Surveys consistently find that around two-thirds of seniors rely on Social Security for a majority of their income, and one-third depend on it for 90% or more of their income. According to the Social Security Administration, 53% of married couples and 74% of unmarried beneficiaries receive at least half their income each month from Social Security.

But without action by the federal government, Social Security funds will face a shortfall starting in 2034, necessitating significant increases in Social Security taxes, decreases in benefits, or both. Considering the political importance of Social Security, it seems likely that Congress will take some action before that to shore up funding and prevent drastic cuts in benefits.

A bigger worry is increasing living costs for retirees, particularly healthcare. Healthcare is already a huge expense for most retirees. Estimates by both Fidelity and Healthview Services are that a 65-year-old couple will spend around $250,000 in retirement just on healthcare premiums, not including out-of-pocket costs and long-term care. Fidelity estimated that healthcare costs rose 11% in 2014, much faster than the rate of inflation.

Most seniors over the age of 65 use Medicare, as it is often more cost-effective than private health insurance. Medicare Part A (inpatient) usually has no premiums for retirees because most have paid sufficient Medicare taxes while working. But the costs of Part B (outpatient), Part D (prescriptions), and Medigap policies to cover out-of-pocket costs have been increasing substantially and is expected to continue to do so.

Part B premiums are projected to rise 5.76% each year through 2024, according to the Medicare Board of Trustees. Part D premiums are projected to grow by 7.1% annually. Premiums for Medigap policies will also increase, but at a lower rate of 3.25% through 2024. Most beneficiaries have Part B premiums deducted from their Social Security benefits, and can also have their Part D premiums taken directly from Social Security as well.

The problem is that increases in Social Security benefits aren’t increasing fast enough to keep pace. Social Security cost-of-living adjustments (COLAs) are expected to average 2.7% per year, according to estimates from the Social Security Board of Trustees. COLAs are based on the rate of inflation in the U.S., and recently we’ve had low levels of inflation. In three recent years, 2009, 2010, and 2016, there was no increase at all. Meanwhile, the average costs associated with Medicare are expected to rise by 5.35% annually.

The average Social Security retirement benefit is $16,020 per year according to the Social Security Administration. By comparison, the average retiree pays $4,300 for full Medicare coverage for Part B, Part D, and Medigap, according to Jester Financial Technologies. So Medicare payments take up 25% of Social Security benefits on average. At present rates of increase, after 10 years a retiree can expect to devote 40% of their Social Security benefits to healthcare, and after 20 years, a senior will spend 55% of Social Security on Medicare payments.

These numbers don’t account for income adjustments. If your income is above certain thresholds, you may pay an Income Related Monthly Adjustment Amount (IRMAA) which is added to your premium. For example, the Part B premium is $121.80 per month in 2016. But if your annual income exceeds $85,000 your payment jumps to $170.50 and if your income is above $107,000 the premium rises to $243.60.

Clearly, retirees and pre-retirees must make plans to make up the difference. Here are some ideas.

1. Health Savings Accounts. HSAs allow you to contribute funds with pre-tax dollars and allow the funds to grow tax-deferred. Funds in the account can be used for qualified medical expenses at any time without tax or penalty. If you’re already enrolled in Medicare, you cannot contribute any more funds to an HSA, but you can withdraw funds.

2. Roth IRAs. Roth IRAs are a good vehicle in many ways to prepare for future expenses. Although Roth IRA contributions are not tax-deductible, the funds grow tax-free and distributions are not taxable. Additionally, unlike traditional IRAs there are no minimum required distributions and you can also make contributions to a Roth IRA at any time, even after age 70 1/2. Another benefit for is that Roth IRA distributions don’t count toward income, so they don’t apply toward the income thresholds that can raise your Medicare premiums.

3. Other personal savings. There are other options as well, such as traditional IRAs, 401(k)s, and regular investment accounts. Just be aware that these options can, at best, defer your tax liability. These do incur taxes when distributions are made, however, and can also raise your income and trigger increases in Medicare premiums.

4. Long term care insurance. Estimates are that 70% of people over 60 will need long-term care sometime in their lives. Although long-term care insurance isn’t right for everyone, long-term care costs are rising rapidly and an extended stay in an assisted living facility can consume a good chunk of your life savings. It’s worth considering whether LTC insurance is right for you and your situation.

5. Stay healthy. Clearly one of the best ways to minimize healthcare costs is to need less healthcare. By following a healthy lifestyle including a good diet and regular exercise you can go a long way to keeping your healthcare costs low.

This video has more information about preparing for healthcare costs in retirement.

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