Retirement medical expenses: Advisors say HSAs can help bridge Medicare shortfalls

Advisers at D.A. Davidson, TD Wealth and Wealth Enhancement Group say health savings accounts and earlier planning can help retirees manage rising medical expenses.

Only 16% of Americans say they are very knowledgeable about what healthcare will cost in retirement, according to a D.A. Davidson survey. Advisors say that gap leaves clients exposed to one of the biggest and least predictable items in a retirement budget.

The online survey, conducted by Big Village among 1,006 U.S. adults, found that 78% of respondents worry about how increasing medical costs will affect retirement. Even so, just 48% have included those expenses in their planning, and only 23% have ever discussed the issue with a financial advisor. Six in 10 said they had already seen someone close to them struggle to pay for care in retirement.

The costs are also rising. Fidelity Investments' latest Retiree Health Care Cost Estimate says a 65-year-old retiring this year will face an average lifetime bill of $185,500, up 7.5% from the previous year, not including long-term care.

Why clients put off planning for retirement healthcare

Andrew Crowell, a financial advisor and vice chairman of wealth management at D.A. Davidson, said younger and healthier clients often dismiss the issue because they do not imagine a worst-case scenario.

“I see it all the time. But waiting too long to plan for future healthcare expenses can severely impact a retirement strategy. One of the best tools we have against far-off costs like these is the power of compound interest over time,” Crowell said.

He said modest, regular contributions can matter far more than many savers realize. “Many folks think that if they aren’t contributing large sums of money every month, it isn’t making a difference. But in fact, even $25 a month invested strategically can compound and start guarding against healthcare inflation,” he said.

Ashley Weeks, a wealth strategist at TD Wealth, said many clients show little urgency when the topic comes up.

“I think two major reasons for this are more immediate financial concerns, and the incorrect assumption that Medicare will affordably cover all health needs. Failing to preemptively plan for retirement health costs can derail an otherwise thorough financial plan,” Weeks said.

For Peter Hoglund, senior vice president and financial advisor at Wealth Enhancement Group, the hesitation is emotional as well as financial. Clients must contend with uncertainty about how much care they will need, when they will need it and how long it will last, which can make the subject feel overwhelming. Personal experience can shape that response in different ways.

“Families that have seen the nightmare health scenario play-out first hand, usually with a parent or loved one experiencing a healthcare event, are able to prepare for this with more clarity, but it can also become an outsized fear and cause under-preparedness in the rest of the financial plan,” Hoglund said.

What Medicare does not cover

Crowell said medical inflation usually runs at least twice the broader inflation rate, meaning current spending on co-pays, prescriptions and hospital visits can understate what retirees will eventually pay. He said many Americans rely too heavily on Medicare and assume it covers much more than it actually does.

“HSAs and other supplemental savings can help address this gap, and talking to a financial advisor about what may or may not be covered by Medicare can make a difference,” Crowell said.

Weeks pointed to a cost that higher-income clients often overlook: the income-related monthly adjustment amount, or IRMAA, a surcharge added to Medicare premiums once income passes certain thresholds. According to the Centers for Medicare & Medicaid Services, the standard Part B premium is $202.90 a month, while people with modified adjusted gross income of $500,000 or more pay $689.90 a month.

Weeks said planning software has become better at estimating costs by taking into account a client’s health, life expectancy and location to project out-of-pocket spending before and after Medicare eligibility begins.

How HSAs can help fund retirement healthcare costs

All three advisors highlighted the health savings account. An HSA allows workers enrolled in a high-deductible health plan to contribute pre-tax money, invest it tax-free and withdraw it tax-free for qualified medical expenses, creating a triple tax advantage. The IRS caps contributions at $4,400 for self-only coverage and $8,750 for family coverage, with an additional $1,000 allowed for savers age 55 and older.

“Medical costs tend to climb faster than overall consumer prices, and as we age, we typically need more care each year,” Weeks said. He urged eligible workers to contribute as much as possible and invest the balance instead of keeping it in cash. “An HSA is a triple tax advantaged account that can compound over decades and assist with medical expenses in a tax-efficient way.”

Many savers are not taking full advantage. Fidelity has found that 40% of HSA holders have not invested their balances, and only 13% of D.A. Davidson respondents named HSAs as a planned source of retirement healthcare funding. Workplace priorities may also be shifting, with a recent Morgan Stanley survey finding that 401(k) plans now rival healthcare as workers' most valued benefit.

Hoglund said HSAs still have limits. Annual contribution caps are modest compared with the possible size of late-life medical bills, and savers have few other accounts designed specifically for healthcare spending.

Stress-testing a plan against a health shock

Hoglund recommends beginning with a full financial plan and then modeling a major medical event to see where the plan breaks.

“Building in the potential for a healthcare event that adds significant expense and understanding what the net result of this can provide clarity and takes away the uncertainty of the unknown surrounding potential healthcare cost,” he said.

From there, he said, clients can decide whether to buy long-term care insurance, direct more savings to HSAs during working years or prepare to self-fund. Plans should also remain flexible enough to handle costs that rise faster than inflation, or come in lower than expected.

“Look at funding options for this – if you are young enough, a LTC insurance policy may be a good tool to mitigate both the inflationary costs of healthcare costs and allow more of your savings to go to fund other retirement goals. If you are not able to purchase a policy, target savings and dedicating funds towards these costs, and protect them from being used for other purposes,” Hoglund said.

Insurance timing matters as well. “Look into your future insurance options. If you wait too long to sign up for your own health insurance plan, it will likely cost much more than signing up when you are still young and healthy,” Crowell said.

With only 23% of Americans having discussed the issue with an advisor, planners have an opening. Separate research from the TIAA Institute shows retirees who work with an advisor report fewer regrets, even though only one in four Americans use one.

“Being prepared for rising healthcare costs is important, but being informed is the first, most crucial step,” Crowell said in D.A. Davidson's release.