Early retirement is a common financial goal that requires careful consideration of covering healthcare expenses before age 65 when Medicare eligibility typically begins.

The cost of a severe illness or accident can devastate a retirement nest egg without adequate health insurance coverage.  Health insurance premiums have increased significantly since the passage of the Affordable Care Act and many people planning to retire early have not considered the financial impact of this higher cost in determining a retirement budget.  Additionally, many coverage options are no longer available on the insurance exchange, as insurance companies have withdrawn or significantly limited their offerings.

Addressing healthcare in retirement should be an essential component of financial planning to increase the likelihood of success and provide needed peace of mind during retirement.  While it can be a daunting task to address healthcare coverage options, this article identifies several options for covering healthcare costs before age 65 and potential planning strategies to mitigate expenses before Medicare eligibility.

COBRA Coverage

The Consolidated Omnibus Budget Reconciliation Act of 1985 (COBRA) is a federal law that, among other things, mandates that health insurance provided by an employer offers employees the ability to continue health insurance coverage after leaving employment.  COBRA allows employees and the employee’s immediate family members covered by a health care plan to maintain their coverage if a “qualifying event” causes them to lose coverage.

An eligible employer is generally an entity with 20 or more full-time-equivalent employees and “qualifying events” include loss of coverage due to:

In most cases, COBRA allows for coverage for up to 18 months. If an individual is deemed disabled by the Social Security Administration, coverage may continue for up to 29 months.  In the case of divorce from the former employee, the former spouse’s coverage may continue for up to 36 months. In the case of the death of the former employee, the widow’s coverage may continue for up to 36 months.

After termination of employment, eligible individuals have up to 60-days to elect COBRA coverage.  COBRA will usually be the least costly health insurance coverage compared to available policies on the exchange. The law requires that premiums cannot exceed the cost to employers for covering active employees.

Depending on the type of insurance and state of residence, it may be possible to extend COBRA beyond the initial 18-month period.  Each state regulates health and other forms of insurance, so it is essential to understand the regulations in your state.  Texas COBRA continuation coverage can provide up to six additional months of coverage after COBRA ends; however, this extra coverage only applies to group health benefit plans issued by insurance companies and HMOs subject to the Texas Insurance Code.  The Texas COBRA continuation coverage does not apply to employer self-funded (ERISA) health care plans as they are exempt from state insurance laws (source: Texas Department of Insurance).

Health Insurance Exchange

Purchasing health insurance coverage through Healthcare.gov can be expensive, and available coverage options have decreased significantly since the passage of the Affordable Care Act.

While expensive, this health insurance resource may be the only option for coverage for individuals considering early retirement, and depending on your retirement income level, individuals may qualify for subsidies, which can reduce the premiums paid.

Health coverage is available at reduced or no cost for people with incomes below certain levels.  In states that have expanded Medicaid coverage, the household income must be below 138% of the federal poverty level to qualify for subsidies.  In all states, household income must be between 100% and 400% of the federal poverty level to be eligible for a premium tax credit that can lower your insurance costs.  The number of people living in a household is the basis for determining the federal poverty level, and the income threshold for a couple would be $17,240 in 2020.

A health insurance subsidy calculator is available at www.healthcare.gov/lower-costs/qualifying-for-lower-costs/ to estimate the potential subsidy based on income level.  A potential way to lower health insurance premiums is to select a high deductible plan and combine it with a Health Savings Account (HAS) described in the following section.

Health Savings Account

Health Savings Accounts (HSA) provide a tax-efficient way to pay for health care expenses as tax-deductible contributions and withdrawals are tax-free if used for qualified medical expenses.

The central requirement for HSA participation is enrollment in a qualifying high-deductible health plan.  For 2020, it refers to a health insurance plan with a deductible of at least $1,400 for self-only coverage or $2,800 for family coverage. For 2020, consumers can contribute up to $3,550 for self-only and $7,100 for families. Individuals age 55 or older can contribute an additional $1,000 per year as an annual “catch-up” contribution.

Once eligible for Medicare, individuals are not allowed to contribute to an HSA; therefore, those planning to retire before age 65 should consider starting an HSA early and investing the balance to benefit from the potential tax-free or tax-deferred growth.

Withdrawals for non-qualified medical expenses are considered ordinary income for tax purposes; however, an HSA can augment an IRA with the added benefit of not being subject to required minimum distributions (RMDs) beginning at age 72.  The flexibility and tax benefits of an HSA makes it an attractive planning strategy for individuals who would like to retire early.

Employer Retirement Health Insurance

Many employers offer retiree health insurance benefits for employees who meet specific requirements, usually based on age and years of service.  As an example, benefits may be available to retirees based on a “Rule of 75”, which means eligibility requires age plus years of service to equal at least 75 with a minimum age of 50.

While the retiree is typically required to pay premiums that are not subsidized by the employer, the cost would likely be less than purchasing insurance through the exchange. The retiree can defer opting in for coverage until it is needed.  It is crucial to review retiree health insurance benefits before retirement to understand the coverage benefits.

The retiree benefit may be limited to supplemental coverage to Medicare, and those married to a younger spouse needing coverage should make sure that retirement healthcare coverage will extend to them before Medicare eligibility.

Conclusion