The 4% Rule, HSAs, and Healthcare Costs in Retirement

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How do you plan to cover healthcare costs in retirement?

It’s a big subject with at least two phases that need to be considered: pre-Medicare and post-Medicare.

Fidelity FIRE

Today’s guest post comes from Max at Max Out of Pocket. I spent a week with the healthcare “bean counter” in Ecuador in the fall of 2019. He’s a friendly guy who is the first to admit that the healtcare billing and charging system we have is a convoluted mess.

That’s one of the reasons he started his blog. He’d like to help those of us on the outside (yes, even as a physician, I was an outsider to this debacle) better understand how health care is paid for and how it affects you.

Today’s post focuses on paying for health care after Medicare kicks in. As we’ve learned here before, Medicare is anything but free, despite being heavily subsidized by you, the taxpayer.

 

The 4% Rule, HSAs, and Healthcare Costs in Retirement

 

Hello! I’m Max. I blog about all things healthcare over at Max Out of Pocket.

The thing is, I nearly let healthcare burn me out a few years back. That feeling of burnout ignited an interest in FIRE concepts that I just couldn’t put out.

I work on the finance side of healthcare. I will be the first to tell you that healthcare finance is a different animal that has basically morphed into an industry of its own. With it comes with stress, pressure, and a lot of waste.

A relatively recent job change put me much closer to clinical operations and I can now see some of the “value-added” from the financial work I do. I take satisfaction from that and for the most part, I am enjoying my career now. So these days, I am much more focused on FI than RE and I don’t see myself hanging it up any time soon.

This FI focus (someone should brand that) has opened some unexpected doors and I am always on the lookout for interesting projects or experiences. Frankly, I am not sure where I am going with my questionable blogging career, but I am pumped to be interacting with the FIRE community in a more meaningful way.

 

Ecuador_Hospital
I had the pleasure of meeting Physician On Fire down in Ecuador at Chautauqua 2019. Thankfully, we didn’t have to work, so we both were able to stay out of the hospital.

 

Tackling Out-Of-Pocket Costs

 

When my household healthcare premiums broke $20,000 a few years back, I took notice. Even though I wasn’t footing the full bill directly, I still took it personally.

Healthcare expenses such as premiums and Medicare taxes are easily the biggest line item of our annual budget. My wife and I are both healthy and rarely use the insurance, so this is even before we get to any of the traditional out-of-pocket costs like deductibles and co-payments.

 

Walmart Mouthwash
As I like to say, I sometimes wish our employer-sponsored medical insurance industry looked more like this. Or maybe we should consider picking one payer. Either way, I just know our hybrid approach has more than a few holes in it.

Planning for healthcare costs seems to be one of the most difficult variables for the FIRE community to solve. My wife is a math teacher and is always solving for X. But healthcare has more than one variable and Max just isn’t smart enough for multivariable equations.

So, I am breaking things down one blog post at a time by covering everything from how much it should cost to get a cat’s teeth cleaned to saving money on our human dental premiums.

Through this process I am finding if we carve out little pieces of this broken system, it slowly becomes more manageable. In turn, we can better plan for the twists and turns healthcare throws at us. In some cases, we can even apply some of our FIRE mastery to it.

So that’s why in my 30’s I am already planning for my Medicare out-of-pocket premiums.

By putting aside a $50,000 portfolio in my Health Savings Account (HSA) and applying the 4% rule of thumb to it, I have put together a Medicare Part B premium drawdown strategy that should cover those premiums forever. Or, that is, at least until they change the rules on me.

 

 

Medicare Part A Premiums – Don’t Retire Too Early

 

Before we get to Medicare Part B, we need to make sure we lock in Medicare Part A. The government got creative and used the first four letters of our alphabet to help us keep the different Medicare programs straight. Just a vowel and a few consonants simplify a multibillion-dollar program.

Medicare Part A is best known for covering inpatient hospital care. It also covers a few other skilled services I never want to use like hospice and home health. There are some out-of-pocket costs to consider with this program, but today we are only talking Medicare premiums.

As long as we don’t retire too early, most of us won’t even need to worry about our Part A Medicare premiums. That’s because once we (or an eligible spouse) work 40 quarters while paying Medicare FICA taxes, we will automatically become eligible for “premium-free” Medicare Part A when we hit Medicare age.

Forty quarters is equivalent to about 10 years of work. You can look to see if you have checked this box yet over on the Social Security website.

Mine looks like this:

 

SSA_Medicare
A 10-year job well done.

If we accidentally hang it up too early, it’s going to cost us some serious money. For the calendar year 2020, the monthly Medicare Part A premium will come in at $458 per month. That’s $5,496 annually. They tier this out a bit once we hit 30 quarters (7.5 working years), so just be careful here.

 

Medicare Part A = $137,400 Investment Portfolio

 

So what kind of investment portfolio would we need to support our Medicare Part A $5,496 annual premium? We can use the 4% rule as a starting point.

Even I can handle this equation. There are technically two ways we can solve for X. We can either divide by 4% or multiply by 25. I typically go with the latter since I am better with multiplication.

 

$5,496 Annual Medicare Part A Premium X 25 = $137,400 Investment Portfolio

 

So by reverse-engineering the 4% rule, we come to find that working 10 years to negate Medicare Part A premiums is equivalent to putting together a $137,400 investment portfolio.

In other words, work the 40 quarters.

Working 10 years on our way to FIRE is usually much easier than building a $137,400 portfolio just to be able to pay our Medicare Part A premiums.

A more conservative 3% withdrawal rate will value these 10 quarters of work at $183,200. There is a relatively low sequence of return risk with this “portfolio”, but it does carry the regulatory risk of changes to the Medicare Part A program itself.

They call it “premium-free” Medicare Part A. It is hardly premium free when we pay about 1.45% of our wages into it. If we work 10 years making 100k per year, we are only paying $14,500 in Medicare FICA taxes to lock in this theoretical portfolio.

 

$1,000,000 X 1.45% Medicare FICA Tax = $14,500 in “premiums”

 

Since a lot of PoF readers command high incomes, some of you might be paying a little bit more than 1.45% into the program. Don’t thank me, though, thank the Affordable Care Act.

 

 

Part B Premiums, Health Savings Accounts, And The 4% Rule

 

Medicare doesn’t let us off that easy for Medicare Part B. We have to pay a premium each month for this part of the program regardless of how much time we spend working for the man.

Medicare Part B covers physician services and other outpatient services such as those provided in the hospital. Physician On Fire’s professional anesthesia services would have been covered under this program for the Medicare beneficiaries he cared for.

Most retired people will pay $144.60 for Medicare Part B in 2020. Multiply this by 12 and it comes out to $1,735 annually.

 

Medicare Premium
Directly from the Medicare website – notice the two-year (MAGI) look back.

Paying Down Part B Premiums With A Health Savings Account

 

The FIRE community seems to be well versed in the triple tax benefit of the Health Savings Account. I sometimes call it the “triple-platinum” retirement account.

If you don’t know, employee contributions through payroll deduction are sheltered/deferred from FICA Medicare, FICA Social Security, and regular federal income taxes. There may even be some state tax relief here depending on our locality. It is a very similar concept to sheltering healthcare premiums through cafeteria plans.

If we look at Health Savings Account IRS regulations (Publication 969), it clearly states that Medicare Part B premiums are considered qualified Medial expenses for tax reporting purposes.

Qualified medical expenses are those expenses that generally would qualify for the medical and dental expenses deduction. These are explained in Pub. 502, Medical and Dental Expenses.

From IRS Pub. 969

Publication 969
Publication 969 – emphasis on number 4

Since it points to Pub. 502, I checked there for some additional support that Part B Premiums are indeed medical expenses.

 

This means we can pay down our Part B premiums directly out of our HSA. This action permanently shelters us from three taxes that we likely deferred/sheltered at the time we contributed to the Health Savings Account (depending on income level, of course).

  • Medicare FICA
  • Social Security FICA
  • Regular Federal Income Taxes

So how much do we need in our HSA to permanently support our Medicare Part B premiums following the 4% rule of thumb? We solve for X again by multiplying by 25.

 

$1,735 x 25 = $43,380

 

So if we can put together a portfolio of about $50,000 into our Health Savings Account and follow a conservative 3.5% withdrawal rate, we could theoretically maintain our Part B Premiums in perpetuity while locking in triple tax savings. I hit that number in my 30’s.

 

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What If I’m A Baller?

 

As I mentioned above, I suspect most POF readers are doing pretty well for themselves #fatFIRE. Don’t worry, I’ll catch up with you one day.

If our annual retirement income is on the higher end, we have more work to do on our HSA. Medicare makes higher-income individuals and households pay higher premiums into the Part B program. So you will want to pay close attention to this table if you fall into these income ranges.

I took this directly from the Medicare website and applied the 3% / 4% rule to all the premium ranges. The goal would be to get our HSA portfolio to these ranges to help us lock in a Part B premium drawdown strategy.

 

Mapping out an HSA Medicare Part B drawdown strategy.

Laws Change

 

All that said, things can change. There was even a bill (Health Savings for Seniors Act) drafted at some point over the summer that would take away the ability for us to pay Medicare premiums with our HSA. This would eliminate our ability to use our Health Savings Accounts for a Medicare Part B drawdown strategy. Here is an excerpt from the proposed bill:

Law Language
I love law language.

The upside of this proposed law is it would allow Medicare beneficiaries to continue to fund their HSA after they qualify for Medicare. In the current state, we are no longer eligible for HSA contributions when we hit Medicare age.

Lastly, there have been some interpretations of this law that suggest we would no longer be allowed to take penalty-free withdrawals for non-medical expenses once we hit 65.

Penalty-free (but not tax-free) withdrawals afte age 65 are allowed in the current regulations and basically allows us to use it as a “triple-platinum” retirement account. The FIRE community is going to have a problem with this if it catches any momentum.

The Max Out of Pocket crew hasn’t modeled any of these changes out yet. Being able to continue contributions into retirement could certainly offset the disallowance of Medicare premiums being considered medical expenses. That said, these bills come and go and until they are actually signed, it is really hard to justify spending too much time on them.

But know this – things will most definitely change.

 

Final Thoughts On The HSA Club

 

Since I joined the Health Savings Account Club back in 2009 I have been lucky enough to be extremely healthy while continuously maxing it out. In my 30’s, I have already accumulated over $50,000 in my account. So in theory, I already have my Part B premiums locked down. I was also able to pay down a several thousand dollar LASIK eye surgery along the way.

I’m in no rush for Medicare eligibility. But in the meantime, I will be working on an additional HSA buffer to account for other out-of-pocket costs like the Medicare deductible and other cost-sharing mechanisms that come along with the program. I may also work on a more conservative withdrawal rate to plan for unexpected adjustments to premiums outside of inflation.

Finally, don’t forget about your spouse when running these numbers. Don’t tell Mrs. Max OOP, but when I initially ran these numbers, I did not include her — the numbers above are per person. So I need to double everything (2X) to about 100k to account for her Part B premiums.

If we make some reasonable predictions on healthcare costs and take some time to understand these programs, we can plan accordingly. Keeping an eye on laws in the hopper can also help us plan for changes to how these programs work.

As always, do your own research and make sure you understand how these decisions impact other variables in these multivariable FIRE equations.

 

[PoF: I like how Max breaks down annual costs in terms of how much of a lump sum you’ll need to set aside to cover it. I explored this concept in my working days with The Power of One More Year. If you’re wanting or needing more, just save up for it!

I’d also like to add that in addition to paying for part A (if you failed to work 40 quarters) & part B with an HSA, Part D (prescription drug plans) and Part C (Medicare Advantage plans) can also be paid for with HSA funds. 

For more information on these aspects of Medicare, please see our previous guest post entitled Healthcare Costs in Retirement – Don’t Make this Big Mistake.

To learn what I’m personally doing to pay for health care coverage prior to Medicare possibly kicking in 21 years from now, see Early Retirement Checklist Part Two: Insurance, Family, and Social Considerations Prior to FIRE.

Finally, as Max encourages, please keep yourself up to date on changes that are sure to come to healthcare and its delivery in the United States over the years.]

 

 

Do you have a plan to cover the healthcare costs that Medicare will not? How much have you set aside for healthcare, in general? What portion of your retirement budget is devoted to healthcare?

18 thoughts on “The 4% Rule, HSAs, and Healthcare Costs in Retirement”

  1. Nice! I neat way to begin to look at covering health care costs. Couple thoughts:

    Don’t forget about Part D and 20% copays! Healthcare is a lot more expensive than just part B IRMAA alone!

    I suggest, since the HSA is not a great account to leave behind, that you need to be more aggressive than 4%. In most historical cases, you are left with WAY MORE when you die if you just take an inflation-adjusted 4% from your retirement savings. You WANT to deplete your HSA, so a 7-10% withdrawal rate would likely be more effective.

    Reply
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  3. Hi FIPhysician!

    Part D is definitely another consideration along with other (non-premium) out-of-pocket costs tied to the Part B and Part A program. We often get patients who are in “observation” status in the hospital who get hit with the cost of “self-administered drugs” because Medicare won’t cover those if the patient isn’t ordered as an inpatient. My understanding is some patients make an attempt to file some of those drugs received in the hospital to Medicare Part D but I am not sure how successful they are with that process. Better than paying full price on hospital drugs!

    Thanks so much.

    Max

    Reply
  4. Nice post.

    Can someone reply here or point me to a “for Dummies” post regarding EXACTLY what Medicare A, B, C, and D are and how the various supplemental plans work. I understand supplemental plans can vary, but much of it seems to be intentionally misleading.

    It may seem simple to you, but as someone who “helped” my two parents and my wife’s two grandparents die over the last 8 years, I found it all VERY confusing. I was 44 when I first got involved trying to help, and I had never given any of it a 2nd though. And by confusing I mean, some stuff was covered, some wasn’t… and having supplemental plans seemed to mess things up further. I was told multiple times stuff like “you have a supplemental BCBS (Blue Cross) and they don’t cover it…. but if you had straight Medicare it would be covered — so why do I have a supplemental plan that doesn’t cover it? You get bills that say BCBS would only cover X amount, so you owe Y.

    Can any of you docs shed any light on this? I’ve read A LOT about this stuff over the last 8 years, and I’m still not clear.

    Reply
    • Hi Mr. Hobo Millionaire:

      Sorry to hear about your family members. Medicare supplement plans usually play pretty nicely with traditional Medicare Part A & B to cover a portion of out-of-pocket costs like deductibles and coinsurances. That said, they usually won’t cover anything not covered by traditional Medicare like statutorily excluded services (i.e. self-administered drugs) or lab services that are not medically necessary (according to Medicare clinical coverage policy). Clear as mud, I know.

      Here it goes in nut-shell though, knowing this is very dialed down: Medicare 101

      Medicare Part A covers inpatient and hospice services.

      Medicare Part B covers outpatient and physician services.

      Medicare Part C (Medicare Advantage) completely replaces Medicare Part A & B should you elect a commercial replacement plan.

      Medicare Part D covers prescription drugs.

      Supplement plans typically cover a portion or all the out-of-pocket costs left by Medicare Part A & Medicare Part B. I have never seen a supplement plan in conjunction with a Part C plan.

      Medicare does not cover nursing home services – we get punted to Medicaid.

      Take care, Max

      Reply
      • Thanks, Max.

        >>Medicare Part C (Medicare Advantage) completely replaces Medicare Part A & B should you elect a commercial replacement plan.

        I think this was my issue (my parents). The BCBS plan that she got did not cover as much as not having it would have covered. I don’t understand why they would be able to sell something like that…

        And just my opinion, but allowing private companies to call anything “Medicare X” is misleading. Medicare Part C makes it sound like it’s still government based, when in fact, it completely replaces anything you had with A and B (and BCBS can outline/decide what they cover or don’t cover).

        Reply
  5. Max is fortunate to have accumulated that much in an HSA. I didn’t have enough years’ exposure to HDHPs as a single person in order to accumulate much in my HSA; it’s only got about $12K in it after I paid out $3.5K a couple years ago after a year of unusually high medical expenses (I hit max out of pocket) . Additionally the HSA’s fees will likely be more onerous than a Vanguard Roth account. Then there’s the IRS annual tax form and record keeping to mess with.

    Therefore I plan on depleting my HSA sooner rather than later, if nothing else just to get rid of one more account to keep track of.

    Reply
    • Hi Lynne – great thought about the fees since they do tend to erode balances. How does your fee structure look? Nothing wrong with keeping things simple and dropping another account.

      If it helps for comparison purposes, the bulk of my H.S.A. is still at Benefit Wallet and their investment platform (SaveDaily) hits me with a flat fee of $2.90 per month to use the platform ($34.80 annually). I would also get hit with the expense ratio on VITSX which is the main fund I access through that account. Not bad.

      Last I looked, my new(er) H.S.A. account hits me up with a monthly admin fee of 0.03% of the balance invested. This comes out to 0.36% annually. They cap it at $10/month ($120 annually), though.

      On 50k, that’s still an $85 annual variance between the two HSA accounts each year. $850 may (or may not) cover a simple lab test in 10 years from now. : )

      I am looking for other options with my current employer.

      Max

      Reply
      • I didn’t know that Fidelity had a no-fee HSA plan. PayFlex is charging something like $5 a month and I don’t recall what the fees would be on the money if I had it invested. Right now it’s just in their version of a savings account making peanuts.

        Thanks to all who mentioned a fee-free alternative. I’ll check into that. I’ve got a small Fidelity 401K with current employer but the bulk of my moolah is with Vanguard. They have plenty of fees on a HSA too… which is unusual for them as their other accounts are very reasonably priced.

        Reply
    • Additionally the HSA’s fees will likely be more onerous than a Vanguard Roth account.

      Fidelity HSA’s do not have fees. If you have an employer HSA, maybe you can transfer most of the balance to a Fidelity HSA and keep the employer HSA for company and payroll contributions.

      Reply
      • I second Wilbur’s comment. I just moved my HSA account from a fee-based bank to Fidelity. There are literally zero fees on these accounts with Fidelity, and they handled the entire move (once I authorized it online).

        Reply
        • Thanks, Wilbur and Mr. HM,

          I will definitely look into that as this new HSA account grows. I have about half of our assets with Fidelity so that should be an easy move (hopefully no transaction fees on either end). I know of a few other similar options but like the idea of keeping everything on one platform at Fidelity.

          Take care,

          Max

  6. “you have a supplemental BCBS (Blue Cross) and they don’t cover it…. but if you had straight Medicare it would be covered —”

    This does not make sense, unless you have a BCBS HMO (Medicare advantage plan aka Medicare C) then sometimes switching to traditional Medicare (aka Medicare A and B) covers more.

    Reply
    • Hospitalist, it was for sure not an HMO.

      And as I stated above just a moment ago (after your comment), I don’t understand why any private insurance company would be allowed to sell anything (especially to the elderly) that doesn’t cover at least equal what they would have had without it.

      And please understand, I’m not anti-business… even insurance companies; I’m just anti-being-mislead.

      Reply
  7. Great post Max! A lot of the costs of health insurance in retirement were ambiguous to us too. We recently sat down with our traditional retirement aged parents and picked their brains on what their plans cost and cover, and it’s eye opening!

    Reply
    • Thanks, Kim.

      I am glad to hear you are picking their brains already. Getting an early start on understanding some of these things will likely help you and your parents and you in the future. I still get fooled on things and I work in the industry. Feel free to reach out if you guys ever get stuck on anything, I am happy to help. : )

      I hope all is well out there in Wyoming!

      Max

      Reply
  8. Q regarding HSA contributions for a young adult.

    My son was on our HDHP health insurance last year. It was a family plan and he was not a dependent, so he was able to contribute the family max to his HSA in 2019 (rather than the smaller individual limit).

    In 2020 he is covered as a single person on his HDHP plan at work (new insurance for him as of Jan 1). I kept him listed on our HDHP family plan as he is still under 26 (so secondary insurance coverage).

    I think this means he can still contribute the family max to his HSA. Is this a strategy you have seen others use? I think I am handling this correctly, but would love confirmation.

    Reply

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