In the aftermath of the 2003 Medicare Modernization Act, plan advisors should be structuring plans so that future retirees can save for retirement without exposing themselves to potentially crippling health insurance premiums.
According to Tom McKenna and Christopher Leone of HealthView Services, the means-testing provisions in the law, which also authorized billions of dollars in federal funding to create the privately-maintained Medicare Advantage program, were created with the goal of shifting some of the government’s responsibility for insuring the elderly back to higher-income retirees. The law does this through means testing based on a Modfied Adjusted Growth Income (MAGI).
Since the income thresholds in the law were not indexed to inflation, McKenna and Leone note, the income levels that would expose retirees to higher premiums are gradually ensnaring more and more people, including many who aren’t “wealthy” by most standards. In fact, they write, without a fix, more than 40% of current HealthView clients could incur Medicare surcharges in the future, and legislation due to go into effect in 2018 will actually lower those thresholds even more.
In order to reduce exposure to surcharges without actually losing income, they recommend that advisors tell their clients about the virtues of a Roth 401(k). Income gained from a Roth account is the only income that doesn’t affect the MAGI calculation.
McKenna and Leone cite a test study, where a healthy saver who saves $2.16 million in a 401(k), beginning at age 35, retires at 65, and lives to age 86, would save over $226,000 in health care costs over the course of retirement if they saved with a Roth account as opposed to making a pre-tax contribution.
While the Roth-vs.-traditional deferral debate normally focuses on whether a plan participant wants to pay higher taxes now (in a Roth account) or later (by paying taxes upon withdrawal, with a traditional account), the authors urge advisors to factor in Medicare premiums in their recommendations. Considering less than 10% of participants currently choose the Roth option, in the event they even have a choice, McKenna and Leone says advisors likely have a lot of clients who would be well-served by thinking about Medicare costs when choosing a 401(k) investment strategy.
A deeper dive can be found in an article McKenna and Leone wrote for the special Outcomes issue of NAPA Net the Magazine. The Outcomes issue features industry thought leaders including Sheri Fitts, PAi’s Michael Kiley, MFS Investments’ Ryan Mullen, Fiduciary Benchmarks’ Tom Kmak, Thornburg’s Rocco DiBruno, Retirement Resources’ Jim Phillips and Patrick McGinn, BlackRock’s Chip Castile, Richard Davies of AB Institutional Investments and execs from Newberger Nerman, American Funds, Pentegra and Transamerica. You can browse content from the issue in the “Focus: Participant Outcomes” section, in the Industry Intel tab.
