The First Financial Surprise of Your Non-Working Years
When most older Americans started working years ago, they got one of the biggest surprises of their young financial lives with the arrival of their first paycheck– the difference between gross and net pay! They were introduced to the world of federal income tax withholding, FICA or Social Security withholding taxes, along with other deductions from hard-earned pay, including those for health insurance, union dues and retirement contributions. Forty years later, retirees are waking to the first financial surprise of their Fulfilling Stage years – the difference between their gross and net incomes. Their discretionary income is under siege primarily due to mandatory medical spending and payments to their kids that are reducing funds available to sustain their lifestyles.
The Fulfilling Stage Paycheck
Instead of payroll deductions they were accustomed to during their working lives, people who have reached the Fulfilling Stage are seeing deductions or necessary payments taken from their spendable income for income taxes, Medicare premiums, Medicare Supplement insurance premiums and payments for long-term care support services. This is through either insurance payments or out-of-pocket expenses, along with a myriad of health-related deductibles and coinsurance amounts. There is no avoiding these medical costs – they are mandatory deductions from our incomes in later life. The magnitude of these payments is a major surprise,averaging $6,000 to $15,000 per year, not considering the extra costs of a possible long-term care event.
The Annual Fulfilling Stage Paycheck looks something like the following:
Pension income, if any
Investment income withdrawals
Work income, if still in the workforce
Total Retirement Income (A)
Federal and state income taxes
Medicare part B and D premiums
Medicare Supplement insurance premiums
Long-term care insurance premiums or out-of-pocket expenses
Medicare deductibles and coinsurance amounts
Support for adult children or grandchildren
Total Mandatory Deductions (B)
Net Income (A) – (B)
As you will see, many people may not have contemplated these mandatory deductions in their income planning, including the need to make ongoing support payments to their offspring.
Fulfilling Stage Paycheck Deductions
So what are these mandatory deductions and how can you manage them? Let’s take a look.
Unfortunately, individuals must pay federal and state income taxes on pension, investment and in certain circumstances Social Security income, unless strategies have been implemented to reduce these tax payments. The tax-deferred nature of annuity and life insurance products can really help here along with the use of tax-free loan proceeds from life insurance contracts. Tax-free income from Roth IRAs and municipal bonds also can have a positive impact on reducing tax outlays. Understanding how their state of residence taxes these sources of income can help them understand how to minimize out-of-pocket tax payments.
Medicare Related Deductions
We are all aware that you become eligible for Medicare when you reach 65 and have to enroll. Medicare has evolved over the years and now has four parts. Some are mandatory for all enrollees; others are optional.
Medicare Part A: Hospital Insurance
Part A generally covers the costs of being in a medical facility. When enrolled in Medicare, individuals receive Part A automatically. For most people, there is no cost to receive Part A, except for any deductibles ($1,364 for 2019). A major surprise for many people is that Medicare does not pay for long-term care support services, as we will discuss later. There are numerous coverage questions and costs relating to this coverage.
For example, according to Medicare.gov if a person stays in the hospital for more than 60 days, they then have to pay a portion of each day’s expenses for each day past the 60th. If they are admitted to the hospital multiple times during the year, they may have to pay that $1,364 deductible each time. After spending 60 days in the hospital, the patient is responsible to pay $341 per day in out-of-pocket costs; this increases to $682 per day after 90 days.
Medicare Part B: Doctor and Other Costs
Medicare Part B generally covers the costs related to doctor visits, tests, medical equipment and home healthcare. Individuals are required to enroll in Part B if they don’t have “credible coverage” from another source – an employer or spouse’s coverage, for example.
With Part B, a means tested monthly premium is paid. According to Medicare.gov, most people will pay $135.50 per month for Part B coverage and have a $185 deductible for 2019. Once they meet the Part B deductible, they generally pay 20% of the Medicare-approved amount for the service.
But in planning for these costs, be aware that there is no cap on the 20% out-of-pocket expense. In general, if Medicare covered medical bills for a certain year were $100,000, the patient would be responsible for $20,000 of those charges, plus charges incurred under the Part A and D umbrellas. There is no lifetime maximum.
Costs Not Covered by Parts A and B
The largest and most important item that traditional Medicare doesn’t cover is long-term care. If an individual is diagnosed with a chronic condition that requires ongoing personal-care assistance, the kind that requires assistance with the activities of daily living, Medicare will cover none of the cost after the first 100 days of care in most all circumstances. This includes help with such activities as bathing and dressing.
According to Medicare.gov, at least 70% of people over 65 will need long-term care at some point in their lives. In planning for these costs, individuals need to consider the protections offered by long-term care insurance, a combination benefit life insurance product with a chronic illness or long-term care rider or an annuity with a rider that can increase retirement income or withdrawals if a long-term care event occurs.
These uncovered costs and/or the cost of long-term care insurance or combination life insurance or annuity products create another new mandatory deduction from retirement income that needs to be factored into income planning.
Medicare Part C: Medicare Advantage Plans
Also known as Medicare Advantage, Part C is an alternative to traditional Medicare coverage. Coverage normally includes all of Parts A and B, a prescription drug plan (Part D) and possibly other benefits. Private insurance companies administer Part C. Depending on the plan, the individual may or may not need to pay an additional premium for Part C coverage. Consumers don’t have to enroll in an advantage plan, but for many people these plans can be a better deal than paying separately for Parts A, B and D.
Medicare Part D: Prescription Drugs
Prescription drug coverage, known as Part D, is also administered by private insurance companies. Part D is required unless you have a prescription drug plan from another source, including a Medicare Advantage plan. The monthly premium depends on your income as it is means tested. In addition to the premium, the individual pays an additional means tested premium amount each month if their income exceeds certain thresholds.
Depending on the plan, the patient may have to meet a yearly deductible before the plan begins covering eligible drug costs.
Medicare plans have a drug coverage gap – a temporary limit on what the drug plan will cover. This is often called the doughnut hole. Each state has insurance options that will close the coverage gap, but these require paying an additional premium.
Medicare Supplement or Medigap Insurance
As I described above, people who only have traditional Medicare – Parts A, B, and D – may incur sizable bills for services not covered by Medicare. To close these gaps, most recipients enroll in some form of Medicare Supplemental Insurance Plan (Medigap) or in a Medicare Advantage plan (see Medicare Part C, above).
Medicare Supplement Insurance coverage is standardized by Medicare but offered by private insurance companies.
Long-term Care Costs and Coverage
To protect yourself against the cost of long-term care support services, there are four generally available options – fully underwritten stand-alone long-term care insurance, a combination benefit life insurance or annuity product with applicable riders, personal resources or Medicaid coverage.
It comes as a surprise to many people that to qualify for Medicaid, they must have nearly no liquid assets (excluding home equity) and a small amount of life insurance – enough to bury them - with qualification requirements varying by state. Under Medicaid, individuals will generally have little or no say on the location and quality of the long-term care support services they receive.
The options of purchasing long-term care coverage and/or using assets to purchase a combination benefit life or annuity product that provides a chronic illness or long-term care benefit are solutions that should be explored to secure some protection against long-term care costs.
Payments to Adult Children – An Ongoing Major Cost
In their new study, The Financial Journey of Modern Parenting: Joy, Complexity and Sacrifice, Merrill Lynch and Age Wave have identified the amount of money parents are giving to their adult children. They call this chunk of change - the hidden economy of support. Said Ken Dychtwald, CEO and founder of Age Wave: “We were floored by what we found.” The study estimated that over $500 billion is being paid to adult children by parents who should be focused on saving for their later years of life.
In the Merrill Lynch Age Wave survey of more than 2,500 parents, which spawned the $500 billion financial support estimate, 63% report having sacrificed their financial security for the sake of their children. What's more, roughly a quarter of parents said they’d be willing to take on debt and pull money from their retirement accounts to support their grown kids.
If you’re thinking the $500 billion in support is just due to the roughly 31% of early adults age 18 to 34 who’ve boomeranged back home to live with their parents, think again. Dan Veto, an Age Wave senior adviser who worked on the study, said only about $100 billion — or 20% of the annual parental support — is attributable to boomerangs.
In fact, the study maintains, 79% of parents are providing financial support to their adult children. “And not just a little; the average was $7,000 a year,” said Dychtwald. Merrill Lynch and Age Wave call this the “family bank.”
The Bottom Line on Your Fulfilling Stage Paycheck
The cost of the family bank, income taxes, Medicare coverage, Medicare Supplement Insurance, long-term care insurance and the payment of the remaining out-of-pocket medical expenses (including deductibles and coinsurance amounts) are the new mandatory deductions awaiting Fulfilling Stage future income streams. These expenses need to be carefully planned for and, to the extent possible, minimized.
In the brave new world of the later-in-life paycheck, the more individuals learn about these new mandatory deductions, the more cash they will have available to enjoy their later years.