Whether you are getting forced into early retirement, or you are choosing to exit the workforce before age 65, your financial challenge remains the same — covering the health care gap until Medicare kicks in.
Many early retirees underestimate the potential cost of paying for private health insurance during the years before they become eligible for Medicare, the federal health insurance program covering those age 65 and older, certain younger people with disabilities, and those with end-stage renal disease.
“I typically find that pre-retirees underestimate the cost of securing private health insurance because they are unaware of how much their total insurance premium would have been had it not been subsidized by their employer,” said Chad Tourin, a financial professional with Coastal Wealth in Fort Lauderdale, Florida. “Someone who has $500 deducted per month for health insurance while working may have no idea that the actual cost is $1,000 per month. In addition to this, I find many pre-retirees have ‘invincibility syndrome’ where they think that because they have always been healthy that nothing will ever happen to them.” (Related: The unexpected problems with early retirement)
Despite the cost of covering the Medicare gap, the average American still retires at age 61, according to the latest Gallup poll data, four years before they become eligible for public health insurance.1
Premiums for private health insurance, even for a few years, can consume an oversized portion of your hard-earned savings, which could undermine your ability to make ends meet throughout retirement. (Learn more: Filing for Social Security retirement benefits)
But don’t despair. Numerous options exist that can help you secure (and pay for) the coverage you need. And under the Affordable Care Act (ACA), health insurance companies cannot deny you coverage nor charge you more for preexisting conditions.
As an early retiree, your coverage options may include:
- Your spouse’s health insurance.
- Retiree health insurance benefits.
- The public marketplace.
- Private health insurance.
- Membership-based group health plans.
New retirees, at any age, should carefully consider all options available to help them secure the coverage they need at a price they can afford. To pay for premiums before they turn 65, the most common strategies include:
“Securing private coverage does not have to be a financial roadblock for those hoping to retire early, but avoiding the financial consequences that accompany early retirement requires planning ahead for an unknown cost,” said Tourin (Learn more: Retiring early? Possible ways to tap savings but sidestep penalties)
Many early retirees take advantage of the Consolidated Omnibus Budget Reconciliation Act (COBRA), which gives certain workers and their families who lose their group health insurance benefits the right to continue their coverage for a limited period of time.
COBRA generally requires that group health plans sponsored by employers with 20 or more employees in the prior year offer employees and their families the chance to temporarily extend their health coverage in the event that they lose their health insurance due to voluntary or involuntary job loss, a reduction of hours, transition between jobs, death, divorce, and other life events.
The Department of Labor notes that continued coverage under COBRA is often more expensive than you would pay while employed, because you would typically be paying for both your own share of the costs and also the portion that your employer previously paid through your benefits package.2
Before you elect COBRA, it is important to compare benefits and costs (premiums, deductibles, copayments, and out-of-pocket maximums) with alternative coverage options.
“Typically, people end up on COBRA initially after leaving work because it is a default option provided to you by the company,” said Tourin. “However, the cost of COBRA can be rather large and so I recommend exploring the public exchanges or obtaining insurance through a health insurance broker, with the determining factor being income level and family size. For those having financial difficulties, there may be some benefits through the federal exchange because of the available tax credits and subsidies.”
Spouse’s health insurance
If you are married, you may be eligible to join your spouse’s health insurance plan for far less than it would cost to secure coverage on your own.
While employers are becoming more restrictive about allowing spousal coverage, especially if the employee's spouse has access to coverage through their own employer, many will still permit it if the spouse experiences a qualifying event (such as a job loss).
Here again, however, it is important for couples to compare costs. If one spouse has a chronic health condition and the other is in good health, it may be less costly for one partner to choose a higher deductible, lower premium plan and the other a low deductible, higher premium plan.
Retiree health insurance benefits
The vast majority of workers with health insurance benefits lose their coverage when they leave their job, but it’s worth checking with your human resources department to find out whether they offer any kind of retiree health insurance benefits.
Some employers, mostly large companies, maintain group health benefits for retirees, particularly during the gap years until Medicare kicks in. And a few generous employers even cover a portion of the premium.
After you become Medicare eligible, you may be able to retain your retiree health insurance, but it “almost always” pays second to Medicare, according to Medicare Interactive In other words, retiree health insurance becomes supplemental. You would still need to enroll in Medicare to be fully covered.
The public marketplace
Under ACA, you cannot be denied public health insurance for preexisting conditions.
ACA’s public health insurance marketplace enables individuals and families to purchase a health insurance policy from their state’s exchange up to 60 days before or after they lose qualifying health coverage.3
Depending on your income, you may be able to claim a premium tax credit and/or qualify for cost-sharing reductions to save money on your coverage purchased through the public Health Insurance Marketplace.
You can get a sense of how much your health insurance may cost by using the Health Insurance Marketplace calculator available through the Kaiser Family Foundation. The tool enables you to enter your income, age, and family size to gauge your eligibility for subsidies and get a sense of how much you might spend on health insurance. It also provides an estimate of whether you may qualify for Medicaid, the federal-state health insurance program for low-income households.
Private health insurance
You can also, of course, purchase private health insurance.
Choosing private health insurance might make sense if you have specific coverage needs or require maximum flexibility to visit out-of-network specialists — and are willing to pay for it.
HealthCare.gov offers an online finder tool to help you locate private health plans available outside of the public Health Insurance Marketplace that meet your needs and budget. You may not claim a tax credit for private plans.
Membership-based group health plan
In the interest of leaving no stone unturned, you should also connect with any professional association, membership organization, or religious group to which you may belong. Some provide members with access to group health insurance coverage at a discount.
Medicaid, the federal-state public health insurance program, may also be an option, depending on your household income.
Medicaid provides health insurance coverage for low-income adults, children, pregnant women, elderly adults, and people with disabilities.
Each state plan is slightly different, but all have an income threshold for eligibility.
You can learn more about your state’s Medicaid program and find out if you qualify here.
You can also fill out an application in the Health Insurance Marketplace, which will tell you which programs you qualify for.
Four possible ways to pay for it
Health care is one of the biggest expenses in retirement, even after you transition to Medicare.
Fidelity Investments estimates that a 65-year-old couple who retires today and is covered by Medicare will need roughly $295,000 (after tax) in today’s dollars for out-of-pocket medical expenses during retirement. That includes Medicare premiums, copays, and deductibles. It does not include any costs incurred for nursing homes or long-term care.4
Many financial professionals recommend retirees earmark 15 percent of their monthly budget for health care expenses, a percentage that has grown as health care inflation continues to outpace the rate of general inflation and life expectancies rise.
But that’s just an average. To better estimate your potential out-of-pocket medical costs during retirement, calculate your medical expenses for the last few years. Don’t forget to factor in your lifestyle, geographic location (health care costs vary considerably from state to state), and any health conditions to which you may be predisposed due to family history, something Tourin said he does with many retired clients.
“It is an important, but difficult, conversation to have with every client because advanced planning for an unknown cost requires digging deep into a client’s family medical history to plan for the possibility of similar illnesses,” he said.
Health Savings Accounts
If you plan to retire early, but are still producing an income, you can start putting extra savings away now to pay for health insurance premiums, deductibles, and copays during retirement.
A Health Savings Account (HSA) tied to a high deductible health insurance plan, if offered through your employer, can help. Certain banks and other financial institutions may also offer HSAs, according to HealthCare.gov.
HSAs are funded with pretax dollars, your contributions can be invested for potential tax-deferred growth, and distributions are tax free if used for qualified medical expenses, including copays, deductibles, and coinsurance fees. HSA funds generally may not be used to pay for premiums. (Related: HSA basics)
For 2021, the IRS permits individuals with self-only coverage to contribute up to $3,600 per year toward their HSA and those with family coverage can contribute up to $7,200.5
Those who plan to retire early can fund their HSA annually and leave those dollars to accumulate for retirement, paying out of pocket for new medical expenses they incur while they are still employed. (Related: HSAs and retirement)
“I highly recommend that everyone contribute to an HSA if afforded the opportunity,” said Tourin. “Unused funds can be carried forward from year to year and can be invested similar to an IRA, which would allow the account to continue to grow and be accessed tax free later in life, when health care costs are typically the greatest. Utilizing an HSA in this fashion would increase your likelihood of success in meeting the unknown future cost of premiums, deductibles, and coinsurance.”
Retirement Health Reimbursement Account
If you are lucky, your employer may also offer a Retirement Health Reimbursement Account (RHRA), which is fully funded by your company and allows you to use contributions tax-free to pay for qualified medical expenses incurred during retirement.
That may include medical, pharmacy, dental, and vision expenses, and, in some cases, health insurance premiums, including those incurred for COBRA and long-term care coverage, as determined by your employer.
RHRA funds could even potentially be used to cover Medicare Part A and Part B premiums after you turn 65.
Money in RHRAs grows through your employer’s contributions and investment earnings.
Penalty free early IRA withdrawal
If you are unemployed and need extra cash to keep your health insurance active, you may also be able to tap into your Roth or traditional IRA before age 59½ without paying the 10 percent early withdrawal penalty.
Likewise, you may be eligible for a penalty-free hardship withdrawal from either type of IRA before age 59½ to cover unreimbursed medical expenses that exceed 10 percent of your adjusted gross income for 2021 (7.5 percent in 2020).6
You would still owe ordinary income tax on any amount withdrawn from your traditional IRA, because they are funded with pretax dollars. Roth IRA contributions are made with after-tax dollars, so you would only owe ordinary income tax when you withdraw the earnings. (Note that you may distribute your contributions to a Roth IRA at any time, penalty free, for any reason.)
Be aware, however, that pulling money out of your retirement account early may increase your risk of outliving your savings. A financial professional can help you determine the potential impact of taking early IRA withdrawals.
If you exit the workforce before age 65, you’ll need to plan carefully to cover the health insurance gap until Medicare kicks in.
By researching your coverage options and exploring all sources of available funding, however, it may be possible to get the protection you need without putting your financial future at risk.
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1 Gallup poll, “Snapshot: Average American Predicts Retirement Age of 66,” May 10, 2018.
2 Department of Labor, “FAQs on COBRA Continuation Health Coverage for Workers.”
3 HealthCare.gov, “Enroll in or change 2021 plans – only with a Special Enrollment Period,” 2021.
4 Fidelity Financial Solutions Group, “Fidelity Retiree Health Care Cost Estimate,” August. 3, 2020.
5 Internal Revenue Service, “Publication 969 (2020), Health Savings Accounts and Other Tax-Favored Health Plans,” Feb. 16, 2021.
6 Internal Revenue Service, “Retirement Topics – Exceptions to Tax on Early Distributions,” Jan. 19, 2021.