Assessing the Inevitable Cost of Healthcare Expenses in Retirement

Assessing the Inevitable Cost of Healthcare Expenses in Retirement The Relationship between Social Security and Medicare Dan McGrath Paul Seidel Josh Jackson, CAS, ALMI

Today s financial advisors are very different from the financial advisors of years past. In the wake of the Affordable Care Act and its accompanying deluge of regulation, advisors are helping Baby Boomers prepare for their retirement in more ways than ever before. However, our industry continues to overlook a significant threat to our clients continued comfortable lifestyle Out of pocket healthcare costs. Most advisors are not including these discussions in the planning process, primarily because the regulations are still very new, and/or they are not familiar with the costs. There is a distinct likelihood that many clients are completely unaware of these costs! While nobody knows exactly what healthcare costs will be in the future, the fact is that these costs will undoubtedly escalate during retirement. The discussion surrounding retirement planning has traditionally taken on the tone of proper allocation of assets, not outliving income, transfer of wealth, and paying future estate taxes. However, the costs outlined below are a very real threat even if our projections are off substantially, this threat still needs to be addressed. Our position is to deal with these issues now, before it s too late. But I ll Be Fine, I Have Social Security... Right? For the roughly 78 million Baby Boomers heading to retirement (at the pace of roughly 10,000 each day!), accounting for Social Security has never been a more integral part of financial planning. Social Security is one of the more important factors to consider when addressing the issue of healthcare costs in retirement. Calculating benefit amounts and deciding the best time to file a claim are quickly becoming some of the biggest hot button issues in the financial industry. When so many clients plan to rely on it as one of the only forms of guaranteed income in retirement, its importance becomes that much more evident. However, depending on a person s individual circumstances, the choices may be as simple as choosing one of two options: Take it as soon as you need it. Delay it as long as possible... because your health just may depend on it. Can it really be this straightforward? The short answer is... it depends. Have you factored in the impact of how future healthcare costs will affect your clients Social Security Income (SSI) benefits? An Overview of the Situation For many middle income married couples, SSI will comprise approximately 20% to 50% of their retirement income. However, one of the most ignored expenses that will be deducted directly from this income is a person s Medicare premiums. These premiums can easily wipe out any cost of living adjustments that retirees will so desperately depend on, and could quite possibly wipe out a person s total benefit as well. There will be a significant amount of retirees that will have the 2

misfortune of not only never receiving any income, but also being taxed on the very same income they never see! Simple financial planning techniques, along with proper utilization of several appropriate financial products available today, would likely help tens of millions of clients control their skyrocketing healthcare costs in retirement, all while providing the very income they will need to maintain their financial freedom. Our goal is to help financial professionals better grasp the far reaching implications of healthcare costs in retirement, and how all the various parts of the puzzle fit together. By understanding the relationship between Social Security and Medicare, advisors can help make the transition into retirement a much easier one for their clients. In no way are we attempting to educate the financial industry on the inner workings of either Social Security or Medicare, as the basics of each program have been well defined by many other institutions. There is an expectation of the reader that there will be a base level of knowledge on how Social Security and Medicare function. So, How Do Social Security and Medicare Interact? Did you know...? That Medicare Part B premiums must be deducted directly from Social Security benefits, whereas Part D has several available payment alternatives? 1 Medicare is mandatory in order to receive Social Security benefits 2 for the following individuals: o Anyone 65 or older that is no longer covered under a credible health plan and collecting Social Security MUST accept Medicare Part A, which is free. o Anyone who is receiving SSI benefits before age 65 and still decides to decline acceptance into Medicare when eligible will have to pay back the entire amount received from SSI. Medicare Parts B & D have late penalties for delaying enrollment, and these penalties will follow a retiree for the rest of their life. The Part B penalty is 10% for each 12 month period missed. The Part D penalty is more straightforward; for each month missed there will be a 1% penalty charged. For example: Client A becomes eligible for Medicare at age 65, but decides to not enroll for 42 months. When he/she does, they will naturally have to pay a premium but since they missed three 12 month periods, they will receive a 30% penalty for delaying Part B coverage. The Part D penalty will be an extra 42% for life. 3 The client may have to pay these late enrollment penalties for as long as they have Medicare! 4 1 http://www.ssa.gov/op_home/handbook/handbook.01/handbook 0127.html 2 http://www.elderlawanswers.com/you can39t opt out of medicare without losing social security judge rules 9017 3 http://www.medicare.gov/part d/costs/penalty/ways to avoid part d late enrollment penalty.html 4 http://www.medicare.gov/your medicare costs/part b costs/penalty/part b late enrollment penalty.html 3

Social Security s Inflation Rate For Future Cost of Living Adjustments (COLA) In 2013 the COLA for Social Security was only 1.7% for beneficiaries receiving SSI benefits. This was a markedly higher increase from years 2012 and 2011, where the COLA was nonexistent (both years had no adjustment). Over the next eight years, the expectation set by Social Security s Board of Trustees 5 is unfortunately not going to be that much higher. In fact, the expected COLAs are only calculated to rise to 2.8% through 2021, and then remain flat for the foreseeable future. The 2012 Trustees Report COLA Increases Calendar year COLA Percent 2013 1.7%* 2014 2.1% 2015 2.1% 2016 2.2% 2017 2.5% 2018 2.6% 2019 2.8% 2020 2.8% 2021 and later 2.8% *Original COLA was scheduled to be 1.9% http://www.ssa.gov/oact/tr/trassum.html But What About Inflation Rates on Medicare Parts B and D? Where Social Security s adjustments are to remain below 3% for the foreseeable future, Medicare s inflation rates are quite different; in fact, they are at least twice as much as what Social Security is calling for. In 2013, the premium for Part B is $104.90 a month, or approximately $1,258.80 annually. 6 If we look at the history of Part B premiums, we would see that the very first premium set by Medicare in 1967 was only $3.00 per month, or $36.00 annually. This means that from a 47 year view of Part B premiums, the historic rate of inflation is roughly 7.85%! In addition, according to the Medicare Board of Trustees report, Medicare Part D is expected to inflate at 7.16% through 2021. 7 Today s National Base Premium Rate (which is the rate that late enrollment penalties and income surcharges are based on) is currently $31.17. The report from the Medicare Trustees is calling for this rate to increase to approximately $54.18 by 2021 almost double in less than 10 years! According to Q1medicare.com, the national average for a Part D plan, or what retirees actually were charged in 2013, is $53.26 a month (approximately $639.12 annually). One can only speculate what this will increase to in the future! 5 http://www.ssa.gov/oact/tr/2012/index.html 6 http://www.medicare.gov/your medicare costs/costs at a glance/costs at glance.html 7 http://www.cms.gov/research Statistics Data and Systems/Statistics Trends and Reports/ReportsTrustFunds/index.html?redirect=/reportstrustfunds/ 4

Other Medicare Considerations Medicare is now means tested Those who happen to be earning above the predetermined income cap in retirement will be hit with a surcharge on top of their Part B and Part D premiums. 8 The income brackets that are currently being used (and the associated surcharges) are as follows: For those earning Part B Part D $85k < N/A N/A $85k $107k Premium + 40% $107k $160k Premium + 100% $160k $214k Premium + 160% $214k + Premium + 220% Premium + $11.60 Premium + $29.90 Premium + $48.30 Premium + $66.60 The Medicare Modernization Act of 2003 paved the way for Part B premiums to be means tested, while also defining what income really is in the eyes of Medicare. 9 The technical definition of income is: Your modified adjusted gross income (MAGI) is the total of your adjusted gross income and tax exempt interest income you may have or the amounts on lines 37 and 8b of IRS from 1040. 10 The Hold Harmless Act In 2009, this legislation was passed, which protects retirees from losing their SSI benefit COLAs due to increases in Medicare premiums. Unfortunately, this only protects retirees from Part B premiums... but not the associated Part D premiums. Note: The Hold Harmless Act will not offer protection to those that are subject to the Medicare income surcharge. If a client earns even one dollar over their allotted amount in retirement, he/she will not have the luxury of their Part B premium being capped at the amount of the SSI COLA adjustment per year. As for those impacted by means testing, the Hold Harmless Act will also not offer protection. What Conclusions Should We Draw From All of This? In order to receive any SSI while retired, a person must accept Medicare when eligible. This makes healthcare costs the only expense that 97% of all retirees are guaranteed to have. They can choose NOT to enroll into Parts B and D, but they will be faced with enormous penalties that will follow them for the rest of their lives. Social Security is only expected to have a COLA of approximately 2.8% going forward (from 2018). Medicare is currently one of the most inexpensive health insurance options available, but it is inflating at over 7% annually. 8 http://www.medicare.gov/your medicare costs/part b costs/part b costs.html 9 http://www.medicareadvocacy.org/infobytopic/partb/partb_10_01.21.premiumissues.htm 10 http://ssa custhelp.ssa.gov/app/answers/detail/a_id/1601/~/calculation of modified adjusted gross income %28magi%29 5

Medicare Part B premiums, as well as surcharges, must be deducted directly from Social Security, and for many retirees the option to pay for Part D directly is usually elected as well. Medicare premiums are based on income, and those that earn in excess of the specified cap will pay higher premiums. Since Social Security s inflation is only at 2.8% (from 2018) and Medicare is inflating at over 7%, while also being paid for directly by Social Security, there will be a point where retirees will not receive the amount of income they were depending on. There will be an increasing portion of aging retirees turning 70 ½ that will be faced with having to withdraw their Required Minimum Distributions (RMDs) in the next few years. Currently, these distributions are considered to be income in the eyes of Medicare. As such, are subject to the penalties that are levied for income. An Example to Highlight the Relationship Between SSI and Medicare: By looking at a 60 year old person (Client A), we can clearly define the direct relationship between SSI and Medicare. The factors that will be used are as follows, and additional premium information may be found in our references. Client A has earned an average $60,000 a year for the last 33 years and will continue to earn that same exact amount until retiring. He/she would like to plan on retiring at either age 62, or 67. Medicare will be accepted at age 65 when retiring at age 62, or the point of retirement for age 67. If Client A opts to retire in 2 years (in 2015), then he/she can expect to generate an income of $15,240, along with a corresponding Medicare bill of $2,740.12. By the year 2042, Medicare Part B premiums finally increase more than the COLA adjustment of SSI, and the actual income Client A will receive will no longer grow, but actually decrease going forward. $40,000.00 $35,000.00 $30,000.00 $25,000.00 $20,000.00 $15,000.00 $10,000.00 $5,000.00 $0.00 Age 60 retiring at age 62 Social Security Benefit Medicare Premiums Actual Income 6

As the graph illustrates, if Client A decides to choose to retire at age 62 and then elects to receive Medicare at age 65, the amount of Actual Income that he/she will receive will never really grow due to the expenses that will eat up any increases in income. Now, if Client A waits until age 67, things begin to look differently. The income at age 85 will be $44,168.37, while the Medicare premiums remain the same at $11,934.66. Actual Income doesn t start to fall until Client A is 95 years old. $80,000.00 $60,000.00 $40,000.00 $20,000.00 $0.00 Age 60 retiring at age 67 Social Security Benefit Medicare Premiums Actual Income Here Comes the Cold Water It is worth repeating that financial advisors must realize that Medicare is being means tested so those clients who happen to earn higher levels of income in retirement will be subject to these extra charges that are levied by Medicare. The Hold Harmless Act will not protect them. If Client A has the misfortune of earning just one extra dollar throughout retirement, he/she can expect to see Medicare premiums eat up his/her Social Security benefit even faster! For example, reference the chart below. 7

$40,000.00 $30,000.00 $20,000.00 $10,000.00 $0.00 Age 60 retiring at age 62 earning one "extra" dollar in retirement Social Security Benefit Medicare Premiums Actual Income Client A s income stays the same ($15,240), but those penalties drive up the cost of Medicare even faster, so he/she can expect to be paying $2,944.53 at retirement in 2015. By age 85, the amount Client A is paying for health coverage has exploded now roughly $16,056. The point where Actual Income gets crossed by Medicare premiums (approximately 2035, or 22 years) is much earlier due to this penalty, and by 2047 Medicare premiums have just about eaten up all of Client A s SSI benefit. As you can see, the consequences of not planning for healthcare costs in retirement will come at the expense of a person s guaranteed Social Security benefit and possible financial freedom. With the inflation rate of Medicare premiums being more than double that of Social Security, the issue only compounds for those that are younger especially if they are subject to Medicare s high income thresholds. What is the Possibility of Being Impacted by a Medicare Income Surcharge? It all depends on how Client A saved and planned during their working years. For the many clients out there who also happen to be smart savers, the odds are high. For those that spent all their money as fast as it came in, then the odds are low. For those who saved in their 401(k) or other taxdeferred vehicles and received an above average rate of return, the possibility is extremely high, especially once they reach age 70. The major issue Client A has to account for is turning 70 and the resulting required minimum distribution (RMD). Remember that improbably large amount of income that you needed to earn in order for Medicare to apply a surcharge? All of a sudden it doesn t seem so difficult to reach. In fact, unfortunately for smart savers, it will be a lot easier than they previously imagined. As these RMDs (which increase each year in retirement) are taken and are combined with Social Security benefits (which may increase as well), the probability of passing the first Medicare income 8

bracket (at the very least!) is not out of the realm of possibility. If we don t intervene, those that have faithfully followed the advice of the financial industry will eventually, if they live long enough, become affected by this surcharge. Why This Could Be Even Worse for Your Female Clients The problem could be even worse for those couples who haven t taken these issues into consideration. What happens if one of them were to pass away without planning accordingly? Statistically speaking, the wife usually outlives her husband. In many cases, the surviving spouse inherits all of these tax deferred assets in order to stretch the amount of growth even further. However, the new issue for the surviving spouse is that he/she will now be in a weaker financial position; while income from investments has remained constant, household income from SSI benefits has decreased. Unfortunately for these widows, these healthcare costs will still be increasing. Your Next Steps There is no doubt that a significant percentage of your clients will be adversely affected by these changes. Luckily, there are still financial instruments that are readily available today that do not subject clients to these problems. We conclude that with simple, prudent financial planning and an understanding of how health costs impact Social Security, advisors today can better assist their clients in solving these problems through the use of proper financial products, like certain annuities (for income replacement), life insurance, Roth investments, and long term care insurance. This is a problem that will not be going away in the near future. As drastic as the figures appear for Client A, the outcomes will only get worse for those that happen to be younger than the example we used. Bear in mind that even if our projections are off substantially, this threat cannot be ignored. Zenith Marketing Group is not only a thought leader on the subject of healthcare costs in retirement, but is also leading the industry in providing financial professionals with the tools and solutions to this emerging retirement challenge. For more information, please contact Dan McGrath, Director of Institutional Marketing at Zenith Marketing Group, at dmcgrath@zenithmarketing.com. 9

About the Authors Dan McGrath Director of Institutional Marketing Dan McGrath, Director of Institutional Marketing at Zenith Marketing Group, has over 20 years of broad financial experience, along with 7 years of healthcare related experience. He is considered a leading expert on healthcare and Medicare related expenses, including their impact on both the financial services industry and the Baby Boomer generation throughout retirement. Prior to his current role, Mr. McGrath served as Director of Healthcare Funding Strategies at HVS Financial, where he was responsible for all content and information on all specifics of healthcare and Medicare. Mr. McGrath also served as a Senior Vice President of Regional Sales for FundQuest, where he was responsible for sales in the Southeast. Mr. McGrath has authored numerous articles and publications on the topics of Medicare and healthcare in retirement. He recently cowrote a module in A View Across the Silos, the textbook used for the Retirement Management Analyst designation at Boston University, and is often invited by Horsesmouth to serve as Medicare expert on their Savvy Medicare Planning for Boomers program. Paul Seidel Assistant Vice President, Marketing Paul Seidel, Assistant Vice President of Marketing, has built a 16 year career in marketing, half of that time spent in the financial services industry. Boasting extensive experience in content creation, ghostwriting, and editing, Paul has been a driving force for product positioning and sales concepts at Zenith Marketing Group. As a licensed life insurance producer, Paul is also in a unique position to understand the needs of and develop to financial advisors. Paul is also a principal of Insware Design Group, LLC, a subsidiary of Zenith Marketing Group that develops software tools to assist in the day to day practice of today s financial advisors. Josh Jackson, CAS, ALMI Senior Associate, Product and Industry Analysis Josh Jackson, Senior Associate, Product and Industry Analysis at Zenith Marketing Group, has been in the financial industry for over 7 years. Having spent the last several years with the Sales Team as a Senior Internal Wholesaler, Josh assists Zenith s Sales and Marketing teams with product positioning insights and competitive industry research. He also plays a major role in conceptualizing, writing, and editing Zenith Marketing's blog, email marketing, and many of its industry publications. This material was prepared to support the promotion and marketing of investment and insurance products. Zenith Marketing Group affiliates, their distributors, and their respective employees, representatives, and/or insurance agents do not provide tax, accounting, or legal advice. Any tax statements contained herein were not intended or written to be used, and cannot be used, for the purpose of avoiding U.S. federal, state, or local tax penalties. Please consult your own independent advisor as to any tax, accounting, or legal statements made herein. 10