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- Retirement isn’t much cheaper than your working years.
- In fact, healthcare costs are often greatest in retirement and they tend to increase with age.
- Retirees can’t avoid taxes, either – Social Security benefits, distributions from 401(k)s, and income from other investments are all subject to taxation.
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Retirement may relieve you from decades of work, but some obligations are inescapable.
It’s crucial to consider two major expenses in calculations for retirement needs: health insurance and taxes.
Fidelity Investments estimates the average 65-year-old couple will spend $11,000 on healthcare in their first year of retirement. While the most basic Medicare plan is free for most people over 65, there are still out-of-pocket costs, such as deductibles, copayments, and prescriptions, to factor in. But Medicare doesn’t cover everything – many retirees pay extra for supplemental health insurance called Medigap.
Plus, some retirement income is subject to taxes like any other earnings, so Social Security benefits and distributions from a tax-deferred retirement account like a 401(k) or IRA aren’t all yours to keep.
Here’s are three expenses that are practically impossible to avoid in retirement:
America’s federal health insurance program for retirees kicks in at age 65. Anyone who had Medicare taxes taken out of their paycheck during their working years will usually not have to pay a monthly premium for Part A, which covers hospital insurance costs after a patient meets various deductibles.
Medical insurance coverage is included in Part B, which costs about $130 a month, on average, for Social Security recipients, and is typically deducted from their monthly benefit check. For new enrollees, people not collecting Social Security, Medicaid recipients, and high earners, monthly premiums in 2019 range from $135 to $460. Once the $185 deductible is met, Part B covers doctors’ services, outpatient care, medical supplies, and preventive services.
Some retirees may also opt to pay for Part D, which covers prescription drug costs. The monthly premium is based on income and ranges from about $12 to $77.
The final Medicare option is Part C, or Medicare Advantage, which is considered an “all-in-one” plan. Retirees either opt for Medicare Advantage or some combination of Parts A, B, and D. Costs for this type of plan depend on the private insurance provider.
2. Supplemental health insurance
Medicare alone doesn’t cover everything. Many retirees opt for supplemental health insurance called Medigap to help cover the cost of high Medicare deductibles, copayments, and coinsurance.
Medigap plans are sold by private insurance companies and cover an individual, so couples must buy separate policies. Some insurers base monthly premiums for Medigap on age, so costs may increase over time.
But Medicare and Medigap are only for people over age 65. Early retirees have to find coverage elsewhere – whether through a former employer, a working spouse’s insurance plan, or a private insurer – until Medicare kicks in. Costs for these types of health insurance run high.
Most retirement income is subject to taxes, with the exception of some Social Security benefits and any Roth retirement account.
Retirees whose only source of income is Social Security don’t pay federal income taxes. But most retirees have income from multiple sources – including investments and retirement-account distributions – and could be taxed on up to 85% of their Social Security benefits.
Distributions from a traditional 401(k) or IRA are taxed as ordinary income since the account was funded with pretax dollars. Required minimum distributions on these accounts begin at age 70 and a half. Pension benefits are taxable as well if they were funded with pretax money.
Distributions from a Roth 401(k) or Roth IRA – which were funded with post-tax dollars – are not taxed in retirement as long as the account has been open for at least five years. But according to Investopedia, regardless of whether the income is taxable or not, all distributions need to be reported on a tax return as income.
Capital gains (income from the sale of investments), dividends, and interest income are subject to taxation, too.
There are several strategies for reducing taxes in retirement, from delaying Social Security benefits to postponing retirement-account withdrawals. By consulting a financial planner, you can figure out what’s best for your situation.