Taken together, the total value of benefits received from Social Security and Medicare can exceed $1.5 million for many retired couples. Yet, due to their complexity and the myriad of options each offers, many retirees leave tens of thousands of dollars in benefits on the table or, in the case of Medicare, they pay tens of thousands of dollars more in out-of-pocket costs than is necessary. Fortunately, with foresight and the right type of planning, anyone can fully optimize the benefits.
Social Security Planning: There’s Much More to it Than You Think
Although most 401(k) accounts have recovered from the beating they took in 2000 and again in 2008 and 2009, Social Security will play a more prominent role in the income planning for pre-retirees who are within 10 years of retirement. With the lifetime value of benefits topping $1 million for a married couple,1 Social Security has become a very material retirement asset. Without the proper planning, it is not inconceivable that thousands of dollars could be left on the table.
The mistake most people make is to wait until they are at the threshold of retirement to choose their Social Security benefit option. When they realize there are more than 180,000 alternative collection options available to them, they may wish they had more time to plan. Between the system’s complexities and the incredible degree to which benefits can differ based on individual circumstances, most people are not prepared for the analysis involved in exploring their options. Yet, unlike choosing Medicare options, which can be changed every year, once the choice of Social Security options is made, it is locked in for life.
Key Decisions with Big Money Implications
The issue that is top-of-mind for most people is when to start taking benefits. Most people are aware they can begin collecting benefits as early as age 62 at a reduced payout. An increasing number of people are learning that, by delaying benefits to age 70, they can increase their payout by more than 30%.2 However, even that fundamental choice requires a thorough evaluation of a number of factors, including your health and your family health history, along with financial and family considerations.
The decision to delay benefits is also affected by the prevailing interest rates. In a low interest rate environment, it might make sense to delay benefits because the increase in payments exceeds the growth of funds earning interest. In a higher interest rate environment, it might make sense to take benefits at full retirement age.
The more complicated issue involves planning around a spouse - whether they are current or past - and the decisions they have made with their own Social Security benefits. Every year, $10 billion in spousal benefits go unclaimed.3 There are at least a dozen different strategies that take advantage of loopholes for married couples, which can add tens of thousands of dollars to their lifetime benefit.
Social Security as an Asset Planning Tool
Less appreciated, and therefore often ignored as a critical planning issue, is the value of Social Security as a retirement asset and its impact on other assets in a retirement portfolio. The fact is, Social Security payments are significant enough that, for the average beneficiary, it would require an asset worth several thousand dollars to replace it. For most people, that would comprise a significant portion of their total net worth.
However, unlike other assets, the unique investment characteristics of Social Security make it a highly desirable asset, capable of providing a hedge against many of the risks associated with retirement portfolios. Because the value of Social Security benefits increase when the value of retirement assets decrease (through withdrawals or market returns), it is considered a hedge against the rest of the retirement portfolio. Also, because the value of Social Security is calculated based on life expectancy, its value increases further for people who live beyond their expected “date of death”. And, because its payments are inflation-adjusted, its value increases even further during periods of higher inflation.
The bottom line is Social Security should be viewed as an asset allocation tool that can form a natural hedge for a retirement portfolio. Although it can’t be treated like liquid assets, the bond-like Social Security asset can and should play a key role in spending and income distribution strategies, including determining the best time start taking benefits.
Optimizing Medicare Benefits: It’s Complicated
As complicated and confusing choosing the optimal Social Security benefits can be, choosing Medicare benefits can make it look easy by comparison. With the average out-of-pocket cost for health care nearing $260,000 in retirement,4 choosing poorly can do more to threaten your financial security than just about anything else. Understanding your Medicare benefits – how to maximize them while reducing their costs – is critical to planning for health care in retirement. It’s not as easy as checking a few boxes when you turn 65. The planning needs to start well ahead of your eligibility.
The Pieces of the Medicare Puzzle
The Medicare offerings can be confusing, even conflicting, leading to choices that don’t necessarily match a person’s circumstances. The wrong choices can result in inadequate coverage and/or more expensive coverage. It is important to understand the ABCs of Medicare and how they fit together to create the right coverage package for you. It’s also important to know that Medicare is not free. The premiums alone (outside of Part A which is free for most people) can amount to nearly $200,000 over 25 years for a couple and that doesn’t include coverage for dental or vision.
Briefly, Medicare offerings consist of four parts:
- Part A covers hospital care, skilled nursing, hospice and some home health care. The coverage is free if you or your spouse has at least 10 years of Social Security work history.
- Part B covers outpatient and preventative care as well as doctor services for an average monthly premium of $109 in 2017. However, the higher up the income ladder you are, the higher your premium, which can run as high as $428 a month in 2017.
- Part C combines Parts A, B and D into an alternative plan called Medicare Advantage (MAP). MAPs are offered competitively and can provide better coverage at less cost – between $0 and $100 a month.
- Part D covers prescription drugs, charging an average premium of $34 per month.
Putting the Pieces of the Puzzle Together
The biggest decision you have to make with Medicare is choosing a plan. Do you choose the original Medicare plan which consists of Part A and Part B and then add Part D? Do you add a Medigap plan to cover excluded expenses and out-of-pocket costs not covered by Medicare? Or do you simply replace your original Medicare plan with a Medicare Advantage Plan (MAP), which includes Parts A, B and D along with some supplemental coverage?
With Medicare plans there is no one-size-fits-all plan, even for spouses because they may have very different needs. Your choice will come down to several factors, including your health, medical needs, lifestyle and finances. Original Medicare is more expensive, but it usually provides more flexibility for choosing providers. MAPs are less expensive and it includes coverage not available in original Medicare, including vision, dental and hearing; but they can restrictive in terms of choosing a provider. Their coverage can also change frequently, while original Medicare coverage does not.
If you plan to travel a lot in retirement and you have extensive medical needs, you would probably want to stay with original Medicare because of the wider availability of providers. If you have extensive prescription needs, you will probably want to use Part D for its broader prescription coverage. If you are extremely healthy and younger, a MAP can save you money. If you can afford it, the original Medicare with a Medigap policy offers the greatest access to providers without the need for prior approval from the insurer.
While your needs may change between now and the time you enroll in Medicare, five years before needing coverage would be the time to begin researching your options based on your current circumstances and your retirement plan.
Planning Strategies to Control Medicare Costs
While most Medicare beneficiaries will pay a total of $1,308 for Part B premiums in 2017, the premium tab will be significantly higher if your adjusted gross income (AGI) exceeds $170,000 ($85,000 for single filers). You could be paying as much as $5,136 per person along with a surcharge for a Part D prescription plan.
The mistake many pre-retirees make is assuming they won’t be earning that much in retirement. But, between a taxable pension and withdrawals from a 401(k) or IRA, it’s easy to reach the higher premium rungs; and that can throw your retirement plan off track. However, there are a number of strategies that keep your income below the threshold. One strategy is to convert your income sources into tax-free stashes of money. For instance, withdrawals from Roth IRAs, annuities and health savings accounts (HSAs) are not included in your AGI.
The Better You Plan, the More You Can Save
As federal programs go, Medicare provides good health care coverage for what you’ve paid in to the system. According to the Urban Institute, a 65-year old couple retiring in 2020 can expect to receive more than $400,000 in health care benefits after contributing just $111,000 in Medicare taxes. But it is a government program, which means it’s big, cumbersome and complex. So, while you should expect to get your fair share of benefits at the lowest possible cost, you’ll need the benefit of advanced planning, which should start within five years of your enrollment date.
1Valuing Social Security Benefits as an Asset. Kitces.com, April 8, 2015
2Is it Smarter to Claim Social Security at 62 or 70? Fool.com. April 8, 2017
3Do Social Security Benefits Change if I Move? Bankrate.com, March 23, 2015
4Health Care Costs for Couples In Retirement Rise. Fidelity. August 16, 2016
Source for figures on Medicare costs and premiums: Medicare.gov