Retiring early is very difficult, but it can be within reach, especially for diligent savers with low expenses, individuals with a strong pension, and high-earning executives with substantial assets. Figuring out when you can retire at any age is driven predominantly by your expenses–not savings–so determining how much income you will require each year to support your lifestyle is the key component of the equation. Particularly for investors who wish to retire early (before Medicare coverage begins at age 65), estimating your health care costs and insurance options is a pivotal factor in determining whether your retirement dreams can become a reality.
Currently, there are five main options for retirees to obtain health insurance coverage before they reach age 65 and can enroll in Medicare:
- Employer-sponsored retiree health plans
- COBRA coverage
- Public exchanges established by the Affordable Care Act (ACA or ‘Obamacare’)
- Private insurance exchanges
- A spouse’s health plan if they are still working or if they have retiree health insurance coverage
These options vary significantly in terms of cost, availability, and plan coverage, so it’s important to understand the pros and cons in advance.
Employer-sponsored health insurance for retirees
Individuals with continued health insurance coverage from their former employer as they enter retirement will generally have an easier time making the leap into early retirement. Employers that offer this type of benefit are typically large companies, schools and universities, and government organizations. Retiree health plans may include several options, including HMO and PPO plans, as well as supplemental Medicare plans at age 65.
These plans often provide superior coverage to other pre-Medicare health insurance options, and possibly at a fraction of the price, depending on the plan and employer’s share of the premium payments. Be advised that the employer may have a different approach to helping cover premium payments for a spouse and/or dependents, so be sure to understand what applies to your situation.
As more employers seek to limit their exposure to the rising costs of health care, a Section 105 plan such as a health reimbursement arrangement (HRA) may begin to replace traditional employer-sponsored retiree health insurance options. With a retiree health reimbursement arrangement, the funds the company has set aside for the employee to pay for qualified medical expenses can be extended to the retired employee to use to pay for qualified medical expenses.
For pre-Medicare retirees, individuals could get reimbursed for all or a portion of premiums for health insurance purchased through public exchanges or private providers, though the reimbursement may disqualify you from the federal premium tax credit. Reimbursements are generally not considered taxable income for the retired employee.
A word of caution: as with so many things in health care, rising costs are leading a growing number of employers to change the retiree benefit programs they offer. Cost-cutting measures can range from tightening eligibility requirements to raising premiums (or passing them on to the retiree entirely) to discontinuing current and/or future benefits altogether. As The Wall Street Journal reports, this has become the de-facto solution for indebted state governments who need to reduce their liabilities and can do little about reducing their existing pension obligations. When developing your retirement plan, ensure you have enough flexibility to account for potential changes to your benefits that are out of your control.
If you or your spouse are participating in your employer’s health insurance plan, you are likely eligible for a continuation of benefits after you retire through COBRA. Employers with 20 or more employees are required to allow certain former employees and/or their spouse or dependents to elect to continue their health insurance (some states also require smaller employers with 2 to 19 employees to permit similar elections, called mini-COBRA).
For retirees, COBRA coverage typically means extending your current employer-sponsored health insurance for up to 18 months after you retire. The cost can be significant though: employers can require former employees to pay up to 102% of the actual premium payment.
For couples with an age gap, you may be able to stay on COBRA even longer: if you are covered by your spouse’s insurance plan and they enroll in Medicare, you may be able to extend COBRA coverage for up to 36 months.
To help make COBRA coverage more affordable, you may be able to use funds from your health savings account or HSA (assuming you have or had a high-deductible health plan) to pay for premiums. In general, insurance premiums are not considered qualified medical expenses for HSA purposes, though two notable exceptions include: payment of premiums during COBRA continuation coverage and after the account owner reaches age 65. While the latter doesn’t necessarily help early retirees, it will factor into the overall picture of expenses and resources during the entire period of retirement.
The Affordable Care Act created a public marketplace for health insurance. Depending on your income and number of tax dependents, you may qualify for a premium tax credit if your income is under 400% of the poverty level (for Marketplace coverage in 2019, the poverty level is $12,140 for a single adult and $25,100 for a family of 4).
According to this calculator from the Kaiser Family Foundation, two 60-year-old adults in Massachusetts could expect a monthly premium payment of $1,091 in 2019 for a ‘silver’ plan, one step up from the bronze plan which offers the most inexpensive monthly premium. Expect costs to vary by age, state, insurer, plan level, and year-over-year. As is standard with health insurance, the less you pay on a monthly basis the more you’ll pay when you need services. These costs could be in the form of deductibles, copays, coinsurance, or simply medical expenses that aren’t covered by your health plan.
Depending on your assets and expected income streams in retirement, it may be possible to qualify for a premium tax credit to help offset the cost or insurance or make it more affordable to buy a more comprehensive plan. The calculation of income is a bit different for the public exchanges than it is on your tax return. Most retirees can estimate their income as the sum of Social Security benefits, withdrawals from retirement plans (e.g., an IRA or 401(k)), pension income, capital gains, interest, and dividends (the full list can be found at Healthcare.gov including what common deductions are excluded from the calculation).
Notably, penalty-free withdrawals from a Roth IRA are generally not included in your income provided it has been at least five years since your initial contribution and you are at least age 59 ½.
The insurance plans available through the public exchanges may not be ideal for retirees who are accustomed to more comprehensive and flexible benefits. Purchasing private insurance is often significantly more expensive than plans available through the public marketplace and you’ll need to make sure not to miss the annual open enrollment period.
While cost can make purchasing private insurance prohibitive, for those with specific medical needs or the resources to work the extra expense into their spending plan, private insurance may be preferable.
A spouse’s health plan
Although most couples seek to align their retirement dates, not all couples do, particularly if there is an age gap or disparate roles and responsibilities at work (usually hours and stress). If the still-working spouse has the option to enroll themselves and their partner in their workplace health insurance, that can be the easiest and most cost-effective option. Unfortunately, if the timing of your early retirement plans are shared, you’ll need to look to one of the other options to bridge the gap in health care coverage until Medicare at age 65.
Working health care costs into your retirement plan
It is highly likely that changes to Medicare and the health care system will continue to dominate the headlines. As of the writing of this article in May 2019, numerous presidential hopefuls have stormed the media with cries to expand Medicare to everyone and to reduce prescription drug prices. While this certainly complicates planning efforts for retirees and pre-retirees alike, it doesn’t need to make or break your whole plan.
There will always be unknowns: estimating expenses, inflation, returns and volatility in the financial markets, your shifting lifestyle preferences, tax laws, and the future of public benefit programs over a quarter century or more. The key is to focus on the things you can control that matter and build in enough flexibility to feel confident that you can pivot if needed.
For example, if health care costs quadruple for the next five years until you qualify for Medicare, can you cut back elsewhere to pay for it? New retirees tend to want to travel, but if you’re in poor health, it isn’t likely you are jet-setting around the globe, which could free up a big part of your budget. Even if you are healthy and the basic cost of coverage has soared, consider whether early retirement is worth cutting back on enjoyable lifestyle expenses to pay for health care costs so you don’t need to dip into your assets (which could impact your plan). There’s no right or wrong answer–but it’s important to recognize that you control the tradeoff.