According to the Employee Benefits Research Institute, spouses retiring in 2014 who take prescription drugs and want a 90 percent chance of having enough money for medical expenses throughout retirement needed an extra $326,000 in savings to pay for it.
Unfortunately, just as rich pension plans have fallen by the wayside, employer-sponsored retiree healthcare benefits also have undergone a similar fate. Because pensioners are living longer, employers footing the bill are on the hook for the medical needs of retirees for an additional 20 years (or more) than in the past.
Earlier this year, the Supreme Court ruled that healthcare pension-type plans originally negotiated as part of a collective-bargaining agreement that has since expired may not have to continue providing healthcare benefits for the life of former employees. No longer are retiree healthcare benefits presumed to continue for life unless there is specific language to this effect in the plan documents. This ruling could impact up to 50 percent of collective-bargaining labor agreements that were drawn up in the 1960s and 1970s, and could result in some retirees today having healthcare benefits reduced or even eliminated.
Retiree Medical Trust
Today, employers are transitioning to different types of retiree healthcare plans in order to offset their risk of providing benefits for long-living former employees. Among them is the Retiree Medical Trust, which is a fund established to reimburse the medical expenses of retired workers. Once the fund is established, the employer hands over management to a third-party administrator, an attorney, an actuary and a financial investor. Money contributed to the trust is not subject to income taxes; interest earned by the trust investments are not subject to taxes; and when money comes out of the trust to pay for retiree medical expenses, it is not considered taxable income.
Another type of plan is known as a VEBA, or Voluntary Employees Beneficiary Association. This is an association funded by workers and/or their employers that pays for healthcare benefits. The VEBA plan sponsors may deduct contributions made to the fund, and workers do not pay income taxes on amounts contributed on their behalf. In addition, all interest earned by the fund and withdrawals made to pay expenses are tax-free.
An employer may establish a 401(h) plan as a pension or annuity to pay sickness, accident, hospitalization and medical expenses for retired employees, their spouses and dependents. Though similar to a pension plan, it must be established and maintained as a separate account. Employer contributions are tax deductible, and retirees pay no income taxes on benefits withdrawn to pay for medical expenses.
Employees who maintain a high deductible healthcare plan (HDHP) while working may be eligible to open a Health Savings Account (HSA). This tax-free savings account can be used to pay for out-of-pocket medical expenses throughout their career or after they retire. The funds grow tax-deferred and can be withdrawn tax-free for medical expenses. Once the account owner turns age 65, funds can be used for any reason – not just medical expenses. However, when a worker/retiree enrolls in Medicare, he may no longer contribute to his HSA account – but he can continue withdrawing from the funds already accumulated.
Retirees should enroll in Medicare when they become eligible even if they have another type of plan sponsored by their employer. As a general rule, medical expenses are reimbursed first by Medicare before any other retirement healthcare plan kicks in.
According to the Kaiser Family Foundation, in 2010 (the latest data available) Medicare beneficiaries spent an average of $4,734 in out-of-pocket healthcare expenses, including premiums for Medicare and other types of supplemental insurance and costs incurred for medical and long-term care services. Clearly, establishing another type of healthcare plan can help retirees from having to pay tens of thousands of dollars toward medical expenses throughout retirement.