The First Financial Surprise of Retirement: Your Client’s Net Retirement Paycheck

March 27, 2015 by Harry Stout

When we started working, we got one of the biggest surprises of our young financial lives – the difference between our gross and net pay! We were introduced to the world of federal income tax withholding, FICA or Social Security withholding taxes, along with other deductions from our hard-earned pay for health insurance, union dues, and retirement contributions.

Forty years later, retirees walk into the first financial surprise of their retirement years – the difference between their gross and net retirement paychecks. Their discretionary retirement income is under siege primarily due to mandatory medical spending reducing funds available to sustain their lifestyles. This is an area where our industry can really help people plan and protect themselves. We need to begin to champion our experience and the product solutions we offer.

The Retirement Income Paycheck

Instead of payroll deductions they were accustomed to during their working lives, retirees are seeing deductions from their spendable retirement income for income taxes, Medicare premiums, Medicare Supplement insurance premiums and payments for long-term care support services either through insurance payments or out-of-pocket expenses, along with myriad of health-related deductibles and coinsurance amounts. There is no avoiding these medical costs – they are mandatory deductions from gross retirement income.

Clients need your help to use suitable insurance solutions to create more discretionary retirement income. Most advisors who have focused on helping their clients generate gross amounts of retirement income must now acquire the knowledge to advise clients on these new mandatory deductions.

As you will see, many retirees may not have contemplated these new mandatory deductions in their retirement income planning.

The New Retirement Paycheck Deductions

So, what are these mandatory deductions and how can we as financial professionals help our clients manage them? Let’s take a look.

Income taxes

Unfortunately, clients must continue to pay income taxes on their retirement incomes unless they have implemented strategies to reduce their 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 can also have a positive impact on reducing tax outlays.

Medicare Related Deductions

We are all aware that you become eligible for Medicare when you reach 65, and, in most cases, 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 ($1,260 for 2015).  A major surprise for many new retirees 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
www.Medicare.gov if you stay in the hospital for more than 60 days, you have to pay a portion of each day’s expenses. If you’re admitted to the hospital multiple times during the year, you may have to pay that $1,260 deductible each time.  After spending 60 days in the hospital, you must pay $315 per day in out-of-pocket costs; this increases to $630 per day after 90 days. Once coverage runs out, you will have to pay the full cost of the remainder of your hospital stay.

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, for example.

With Part B, a means tested monthly premium is paid. According to
www.Medicare.gov, most people will pay $104.90 per month for Part B coverage and have a $147 deductible.  Once your clients meet their Part B deductible, they generally pay 20% of the cost of the service.

However, when 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, they 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 you are 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. This includes help with such activities as bathing and dressing.

According to www.Medicare.gov, at least 70% of people over 65 will need long-term care at some point. You need to have your clients 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 retirement 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, your client may or may not need to pay an additional premium for Part C.

Your clients 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 your client has a prescription drug plan from another source, including a Medicare Advantage plan. The monthly premium depends on their income. In addition to the premium, your client may pay an additional means tested premium amount each month that ranges from no premium or up to $70.80 per month, for 2015.

Depending on the plan, your client 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. More and more insurance professionals can now offer this product to their clients. To offer this coverage, new training and education and licensing may be needed.

Long-Term Care Coverage 

To protect your clients against the cost of long-term care support services, there are generally four 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 assets 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 industry solutions that we can provide. Getting the training and proper support to understand the product landscape are what financial professionals should seek out. This knowledge will better enable you to work with your clients to plan for these costs.

The Bottom Line on Your Client’s Net Retirement Paycheck

The cost of income taxes, Medicare coverages, 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 your retiring clients. You need to help them carefully plan for and, to the extent possible, protect themselves against these expenses. Luckily, the industry has a full set of product solutions to help you in this effort.

In the brave new world of the net retirement paycheck, the more you learn about these new mandatory deductions, the more valuable your services will be and the more you and your clients will earn.

Originally Posted at NAFA Annuity Outlook Magazine on March 2015 by Harry Stout.