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A Medicare Primer: What It Is & How It Works
According to a recent Nationwide survey of adults aged 50 or higher, over half of participants couldn’t estimate their annual retirement healthcare costs. In addition, 72% said they wished they better understood Medicare coverage.
If you’re not sure how Medicare works and what it pays for, understanding your projected retirement medical expenses (and total costs) will be difficult. Let’s walk through the basics of Medicare below.
Medicare is a federal (government) health insurance program funded primarily from three sources: general revenues, payroll taxes, and beneficiary premiums. Medicare also covers certain younger people with disabilities, as well as people with End-Stage Renal Disease (irreversible kidney failure requiring dialysis or a transplant). In short, it’s a way for people to have healthcare coverage as they get older and leave the workforce.
Medicare comes in four different parts, and each part covers a separate healthcare-related cost:
Part A covers inpatient hospital stays, care in a skilled nursing facility, hospice care, and some home healthcare.
Part B covers services such as doctor visits, medical supplies, outpatient care, chiropractic care, lab work, outpatient therapy, behavioral health, and prosthetics, as well as certain preventive services. Medicare Part B will cover most routine medical expenses, as well as ER and urgent care services.
This type of Medicare health plan is offered by private companies that contract with the government to provide you with all your Part A and Part B benefits. If you’re enrolled in a Medicare Advantage Plan, most Medicare services are covered through the plan and aren’t paid for under original Medicare (Parts A and B). Most Medicare Advantage Plans offer prescription drug coverage.
Medicare Advantage Plans are offered by insurance companies (and other private companies) approved by Medicare. The plans may also offer prescription drug coverage that follows the same rules as Medicare Prescription Drug Plans.
Part D adds prescription drug coverage to original Medicare (Parts A and B), some Medicare Cost plans, some Medicare Private-Fee-for-Service plans, and Medicare Medical Savings Account (MSA) plans.
Medicare typically does not cover long-term care, dental care, hearing aids, or vision care.
Medigap policies are run by private companies to fill the “holes” that exist in regular Medicare coverage (i.e., healthcare-related costs that aren’t covered by Medicare payments, such as co-payments, deductibles, and healthcare coverage when you travel outside the USA). You will pay a monthly premium for this type of policy.
Most Medigap policies do not pay for prescription drugs. Also, these policies typically don’t pay for long-term care, dental costs, vision costs, hearing aids, eyeglasses or private-duty nurses.
Most people start thinking about Medicare when they are close to age 65. You automatically become enrolled in Medicare Part A and entitled to benefits when you apply and are approved to receive Social Security benefits (once you turn 65). If you are not yet receiving Social Security benefits, you may actively enroll in Medicare yourself by contacting your local Social Security office. You can also apply for Part A benefits at any age if you meet the Internal Revenue Code (IRC) definition of disabled or are suffering from certain diseases.
You must enroll in Part B when you are first eligible (generally when you turn 65), or immediately after losing other satisfactory health insurance coverage. However, if you have other satisfactory health coverage (through an employer, for instance), you are not required to enroll in Part B when you turn 65. But in this case, you may have to pay a late enrollment penalty (in the form of a higher premium) when you finally do sign up for Part B.
If you or your spouse has worked and paid Medicare taxes for at least 40 quarters (10 years), Part A of Medicare is free. However, Part B enrollees must pay a monthly premium, which starts at $134 per month but can increase based on your past income. In addition, Part A and Part B each have annual deductibles you must reach before Medicare starts paying. Finally, Part C and Part D have monthly premiums that vary based on the plan you choose.
Unfortunately, not only is Medicare not free, it doesn’t cover things like long-term care premiums, which could become very significant costs depending on how long you live. Healthview estimates the average couple retiring at age 65 in 2018 will be liable for up to $404,000 of non-Medicare-covered expenses. And if you use 401(k) funds to pay for those costs, you’d pay an extra $134,000 in taxes.
Because of their triple tax benefit, HSAs are a uniquely tax-advantaged way to pay for medical expenses in retirement. By contributing tax-free and investing those contributions like a 401(k), accountholders can grow medical nest eggs to pay for what Medicare doesn’t cover.
Once you enroll in Medicare, you can’t contribute to your HSA anymore, but you can still use your current funds to pay for qualified medical expenses tax-free. Also, once you turn 65, you can use HSA funds to pay your or your spouse’s Medicare premiums tax-free (although Medigap premiums aren’t an eligible expense). In addition, you can use HSA funds to pay for a set amount of long-term care premiums each year (see IRS Publication 502 for the exact numbers).
If you’re looking to build a comprehensive retirement strategy, HSAs are an essential piece of the puzzle. They’re the hands-down choice for getting the most tax savings on healthcare costs and keeping your 401(k) funds for non-medical expenses. Check if you’re eligible to make HSA contributions here or start the enrollment process if you’d like to get started.
What You Need to Know About Medicare and HSAs
If you’re getting close to 65, you’re probably considering signing up for Medicare. If you have an HSA, here are a few things you need to know:
Just because you turn 65 doesn’t mean you’re automatically enrolled in Medicare. If you decide to keep working after age 65 and are covered by your employer’s health insurance, you don’t have to sign up for Medicare. And if you’re HSA-eligible, you can keep contributing to your HSA until you do decide to enroll for Medicare.
If you sign up for Medicare after you turn 65, though, your official coverage start date will be retroactive to either your 65th birthday month or 6 months before your enrollment date, whichever is smaller. This means you should prorate your HSA contributions for that tax year to reflect the number of months you were HSA-eligible.
Note: If your birthday isn’t on the first day of the month, your coverage starts on the first day of your birthday month. If your birthday is on the first day of the month, your coverage starts on the first day of the previous month.
If you’re enrolled in any part of Medicare, you aren’t eligible to contribute to an HSA, because Medicare isn’t an HSA-eligible high-deductible insurance plan. However, if you had an HSA before you were on Medicare, you can keep it, and any funds in your HSA are yours to spend on qualified medical expenses.
If you’re enrolled in Medicare and have existing HSA funds, you can also use your HSA funds to pay for your Medicare premiums. However, you can’t use them to pay for Medigap premiums. Medigap policies are regarded as “supplemental,” so they aren’t eligible to be covered with HSA funds.
If your spouse enrolls in Medicare, you’re still eligible for and can contribute to an HSA, because HSAs are individually-owned. And you can use your HSA funds to pay for eligible expenses for your spouse, even though he/she isn’t HSA-eligible. However, you can’t pay for your spouse’s Medicare premiums until you turn 65.
If your spouse enrolls in Medicare and you have no dependents on your health plan, your HSA contribution limit will be $3,600 for 2021. If you were covering your spouse on your health insurance plan before he/she enrolled in Medicare, you’ll need to prorate your HSA contributions based on how many months you had family coverage and how many months you had individual coverage.
Want to know everything about Medicare and HSAs? Get the ultimate guide below.