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6 Ways to Protect Against the Biggest Threat in Retirement

It’s the job of a financial professional to help clients pay for their health care costs in retirement. But what if you could help them control these costs, too?

You can’t beat the system. But you can understand the relationship between Medicare and retirement income, consider five investment options that may not be top of mind, and have this conversation at the beginning of all client relationships. By doing these things, you can help your client control health care costs in retirement, fund those costs and ultimately save their Social Security benefit.


Medicare: What You Need to Know

Let’s start at the beginning: defining what we mean by “controlling health care costs in retirement.” The first step is to develop a working knowledge of how Medicare operates, as that knowledge is a critical component of successful planning — i.e., successfully controlling health care costs.

Medicare premiums are based on taxable income: The more income you have, the higher your costs. The premiums are derived by the Centers for Medicare & Medicaid Services through the use of the Medicare means testing brackets or, as it is known, the income-related monthly adjustment amount (IRMAA).

Medicare clearly outlines what constitutes “income.” Simply, any income that shows up on lines 37 and 38b of your client’s federal tax return is used to determine their premiums.

Unfortunately, maximizing the amount of income that hits those tax return lines is exactly what most financial professionals have helped their clients do.

First, you must understand what constitutes income by Medicare’s definition. After that, you will see that if the following alternative investment options are included in a client’s strategy early on, they can help save a client’s Social Security benefit, lower their Medicare costs and put money back into the overall retirement portfolio. All of these things will help you demonstrate that you truly are looking out for your client’s best interests, which as we know is essential in a post-DOL world. Furthermore, looking out for a client’s best interests theoretically will help you maintain that client relationship for years to come.

Let’s take a step back and address one point mentioned previously: saving a client’s Social Security benefit. What does that mean? An individual or couple pays for the bulk of their Medicare through their Social Security check. So whatever Medicare premium your client is responsible for comes directly out of their Social Security check. By implementing a strategy to control and minimize Medicare costs, you literally are saving your client’s Social Security benefit.


Alternative Investment Options

Understanding Medicare’s definition of income allows you to consider alternative investment vehicles that do not count as income according to Medicare’s determination.  Before you sit down with clients to discuss paying for health care in retirement, you may want to consider these sometimes overlooked and often underused investment options:

1) Roth IRA: In terms of controlling health costs in retirement, a Roth investment is arguably the easiest option. Although an individual Roth IRA has income limitations, the Roth provision through an employer’s retirement plan, such as a 401(k), does not. Clients should ask their employers if they offer a Roth alternative to the company 401(k) plan.

2) Life Insurance: For those under 50 years old, life insurance is a powerful financial option to help control health costs in retirement. Permanent life insurance provides the ability to generate income in retirement through the cash value portion of the plan. If structured properly, this cash value is deemed a loan to the policyholder and does not count as income to the IRS or in terms of Medicare’s IRMAA. Another great option is to add a rider for long-term care (LTC) coverage onto the policy, which can help fund a portion of LTC needs without raising taxable income or, in turn, Medicare premiums.

3) Certain Nonqualified Annuities: Certain types of annuities do not count as income. These nonqualified annuities are variable annuities that have been annuitized. Once annuitization happens, a portion of the income generated is exempt from taxation.

The amount that is tax-exempt is dependent on how long the money has been invested in the annuity, the age of the annuitant and the structure of the annuity itself.

When annuitized, the income created from a nonqualified annuity has the luxury of generating a tax exclusion ratio. This tax exclusion ratio, which can range anywhere from 20 percent to 80 percent, can help generate much-needed income that is not recognized by Medicare or the IRS. This means that 20 percent to 80 percent of that income is not included in the IRMAA calculation.

4) 401(h): A 401(h) plan is a retirement vehicle to cover medical expenses. This account can piggyback on an employer retirement plan. In addition, unlimited assets can be deposited into a 401(h). Incoming funds are tax-deductible. Assets grow tax-deferred. When those assets are distributed, that distribution is tax-free assuming the money is used for health expenses for the owner, their spouse or a dependent. This account cannot be discriminatory. If one person elects to place a certain percentage of their retirement assets in the plan, then all participants must do the same.

This investment option is perfect for small-business owners with a couple of participants in the plan. The idea is to help fund the health costs of the account owners, in addition to anyone who may become a dependent later in life, such as a parent who did not plan for LTC events. Once the 401(h) is created, investments can include anything, such as stocks, bonds, annuities, life insurance or mutual funds.

5) Health Savings Account (HSA): HSAs operate similarly to 401(h) accounts — assets do not impact “income” because they are used for health expenses. Unlike a 401(h), though, there is an annual investment limit. HSAs are established by an employer and are good for businesses of all sizes. Most employers who offer a high-deductible plan have the HSA option. Employees typically aren’t aware of this option, nor do they fully understand it. 

6) Home Equity: One of the greatest assets many retirees have is the equity in their homes. When clients tap this equity, either through a home equity loan or a reverse mortgage, they essentially are giving themselves a loan. Therefore, it does not count as income. Leveraging home equity gives retirees yet another opportunity to access cash to help offset any costs and control the possibility of generating too much income in any given year.


Timing Is Everything

Understanding how Medicare works and considering a few alternative investment options that can bolster your client’s retirement comfort are only two-thirds of the solution. The final takeaway is to know how important it is to start this conversation at the beginning of the client relationship. The long game is the winning game when it comes to managing health care costs in retirement. As you’re well aware, many investment plans take time to mature before yielding healthy returns.

While you can’t beat the system, you can learn to operate within it to better support your clients through smarter financial planning. The impact of using one or more of the five investment options listed here can mean the difference between clients enjoying their retirement versus struggling to make ends meet.


Dan McGrath  is co-founder of Jester Financial Technologies. He is the author of What You Don’t Know About Retirement Will Hurt You! Dan may be contacted at [email protected]

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