Earlier this year Fidelity Investments estimated that a couple retiring today at age 65 can expect to pay $230,000 in Medicare premiums and uncovered expenses over the course of their golden years… a poisonous reality that must be met in addition to regular retirement savings. The fact that rising health care costs also tops the biggest concerns among many retirees means finding a antidote for both saving and investing appropriately to offset the burden of future medical expenses.
To address healthcare concerns and future living costs, I often suggest that soon-to-be retirees maximize their funding of a Roth IRA and consider taking a more aggressive, long-term stance with the investments inside of it. You are likely familiar with the popular features of the Roth IRA, including tax-deferred growth and tax-free-withdrawals, but many haven’t considered how additional features can be used to offset future medical expenses, such as the fact that there are no required distributions at age 70½ and that owners can invest in anything they want within their Roth.
To start, since there are no required distributions at age 70½, investors may take a longer-term approach on the types of investments earmarked for future medical expenses. For instance someone aged 60 and planning to retire in five years, can be aggressive if they’re healthy and don’t anticipate needing access to the Roth funds until they are, say, 75 … an age commonly associated with at least one major medical or long-term care service need.
Thus, a 60 year-old has 15 years until the funds are likely to be required. If it were just five years instead, there would be different considerations in the investments selected since there is less time for average returns to work in an investor’s favor. That being said, Roth investments reserved for medical expenses that are 10 or 15 years away may be a great place to increase your overall risk tolerance, with considerations given toward growth-oriented mutual funds, ETFs, or even popular individual growth stocks like Apple, Google, or Amazon.
The math is pretty straightforward. Take for example a 55 year-old who wants to retire at age 66. By contributing $6,000* per year for the next 10 years, and investing it aggressively during that period of time (assuming a 10% rate of return) they will accumulate nearly $120,000. If, after 10 years, a retiree doesn’t need to access this asset for another 10 years, even if they’ve earned a rate of return of only 6%, at the end of that period they’ll have nearly $215,000 for medical and /or long-term care needs.
As an added bonus, if you stay healthy and don’t need to use the funds, or if your number comes up before you need to access the funds, these assets may transfer income tax free to your heirs or a favorite charity.
One caveat, of course, is the fact that there are income limits for the Roth IRA. For tax year-2011, investors begin to phase out of eligibility if they’re Adjusted Gross Income is above $169,000 for a married couple (filing jointly) or $107,000 for a single or head of households. At the other end of the spectrum, if you’re already retired and living on a pension, dividends, or other passive income sources like rental income, you may not be eligible since you must have earned income to qualify.
If the contribution rules present an issue, two solutions come to mind: 1) Ask your employer to begin offering a Roth 401(k). This option was actually made available as part of the Pension Protection Act of 2006 but has only lately began to show up as an available option, although for the most part only with larger employer group plans. 2) Seek out a low-cost, no surrender charge annuity to help grow assets tax deferred. While an annuity option isn’t as ideal as a Roth (because taxes will be due on any gains at withdrawal) an aggressive investment stance plus tax-deferral over time may help reduce the overall tax burden.
Finally, funding a Roth for future medical costs can also help early retirees bridge the gap between employer-provided health insurance and the time when they become eligible for Medicare. One of the biggest reasons people put off early retirement rests with their inability to find or afford individual health coverage. With a healthy Roth IRA account balance, however, you can leave work at age 63½ and exercise your employer’s 18-month COBRA option to bridge the coverage gap, while ideally paying for it tax free from your Roth.
As people continue to live longer and demand quality health care, medical costs will continue to plague current and future retirees. Pre-retirees need to deal with their future needs by taking their medicine and not only fund a Roth IRA or Roth 401(k) but to also invest it in such a way to meet those future obligations.
*Annual Roth IRA contributions are limited to $5,000 per year, per individual unless you are over the age of 50 and therefore may be eligible to contribute up to $6,000. Other requirements may apply