As you get older, it’s no surprise that you usually have more healthcare needs. Medicare can cover the bulk of your medical expenses after you turn 65, but it still leaves some potentially large gaps. A Fidelity study found that the average 65-year-old couple will pay about $295,000 in out-of-pocket medical expenses during their lifetimes — even though they’re covered by Medicare. Healthcare continues to be one of the largest expenses in retirement.
But you may be eligible for tax breaks to help cover these healthcare costs, and new rules recently expanded these benefits. Here’s how to make the most of tax benefits for medical expenses even after you’re on Medicare, and some strategies to boost your savings even more.
When Medical Expenses Are Tax-Deductible
Many medical expenses can be tax-deductible, but the rules have always been complicated: To qualify for this tax break, you need to itemize your deductions, and then you can only deduct the expenses after they exceed 7.5% of your adjusted gross income. That means if your income for the year is $50,000, you can only deduct the portion of your medical expenses that are more than $3,750. The threshold for deducting these expenses has moved up and down from 7.5% to 10% over the past few years, but the 7.5% level was made permanent by the year-end COVID-19 relief bill signed in December 2020.
A long list of medical expenses are tax-deductible, including the deductibles and co-payments you pay for care that is covered by insurance and your out-of-pocket costs for many expenses that aren’t covered by insurance. Even after you’re on Medicare, you may still have some big medical bills. For example, if you don’t have a Medicare supplement or Medicare Advantage plan, you may have to pay deductibles and co-payments for hospital stays, doctor’s visits and other healthcare costs. If you have traditional Medicare and don’t have Part D prescription drug coverage, you have to pay most drug costs yourself. And even with Medicare Part D, you may still have to pay some large co-payments for your medications, especially if you take expensive brand-name or specialty drugs. Hearing aids and some other common expenses aren’t covered by Medicare, either. “I don’t think people realize that Medicare doesn’t cover most dental or vision care,” said William Stuart, director of strategy and compliance for Benefit Strategies, a healthcare benefits consulting firm.
Some common expenses for retirees that are tax-deductible include the cost of glasses and vision care, hearing aids, most dental care, programs to stop smoking, mileage to and from medical appointments (17 cents per mile in 2020), chiropractic care and acupuncture, said Mary Kay Foss, a CPA in Walnut Creek, California, who works with many retirees. “Weight loss programs may deductible if recommended by a doctor, but the food is not deductible,” she said. You may also be able to deduct some costs for home modifications made because of a medical condition or disability, such as widening doors or installing a wheelchair ramp.
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If you have a long-term care insurance policy, you can also deduct a portion of the premiums you pay for that coverage based on your age — up to $1,630 in 2020 for ages 51 to 60, up to $4,350 for ages 61 to 70, and up to $5,430 for 71 and older (you can deduct a smaller portion of the premiums at younger ages).
Qualified long-term care services may also be deductible, but the requirements are complicated. You can only deduct the cost of certain services that are required by a chronically ill individual and provided under a plan of care prescribed by a licensed healthcare provider. For details and a full list of tax-deductible medical expenses, see IRS Publication 502, Medical and Dental Expenses.
A Strategy To Benefit From the Medical Expense Tax Break
Despite this long list of tax-deductible expenses, many people don’t take the medical expense deduction. That’s because you can only deduct your medical expenses if you itemize your deductions — and most people don’t itemize now that the standard deduction is so much higher than it had been in the past. In 2020, the standard deduction is $12,400 for single taxpayers and $24,800 for married filing jointly. Married taxpayers who are 65 and older can each claim an extra $1,300 standard deduction (or $1,650 if single).
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Using a bunching strategy could help you qualify to itemize. “Senior clients often use the standard deduction, but some of them will itemize,” Foss said. “We encourage people who have one large medical expense, like a hearing aid, to try to schedule other expensive medical items in the same year, such as dental work or a dental implant.”
Tax-Free Withdrawals From a Health Savings Account
Another way to get a tax break for medical expenses, even if you don’t itemize, is to use tax-free money from a health savings account. But you need to plan in advance. You can’t make new contributions to an HSA after you enroll in Medicare, but if you already have an HSA you can withdraw the money tax-free for out-of-pocket medical expenses at any time, including deductibles and co-payments, prescription drugs, and vision, dental and hearing care, plus other eligible expenses. After you turn 65, you can also withdraw money tax-free from the HSA to pay premiums for Medicare Part B, Part D and Medicare Advantage (but not Medigap) coverage. Even these basic costs can add up: In 2021, most people pay $148.50 per month for Medicare Part B — or from $207.90 to $504.90 per month if your modified adjusted gross income is more than $88,000, or more than $176,000 if you’re married filing jointly. Also, most people don’t pay premiums for Medicare Part A because of their own or their spouse’s work history, but anyone who doesn’t qualify for premium-free Part A benefits can withdraw money tax-free from an HSA to cover those expenses, too. You can reimburse yourself from the account even if you pay Medicare premiums automatically from your Social Security benefits.
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And the Coronavirus Aid, Relief and Economic Security (CARES) Act expands permitted HSA withdrawals to include over-the-counter medicines, too, such as pain relievers, allergy medications, and cough and cold medicines.
Also, some potentially large long-term care expenses may be reimbursed from an HSA. “Custodial expenses aren’t a qualified expense for a health savings account, but if a long-term care facility itemizes specific qualified services – like outpatient physical, occupational, or speech therapy – that aren’t reimbursed by Medicare, patients can reimburse these expenses tax-free from an HSA,” Stuart said.
A Strategy To Increase Your HSA Benefits
Even though you can use HSA money for current medical expenses, you can build even bigger benefits if you let the money grow tax-free in the account for future medical bills. If you haven’t enrolled in Medicare yet, it’s a good time to use the last few years before retirement to boost your HSA savings, which can help you pay for medical expenses in retirement. You can make HSA contributions in 2021 if you have an HSA-eligible health insurance policy with a deductible of at least $1,400 for single coverage or $2,800 for family coverage. You can contribute up to $3,600 for the year if you have single coverage, or $7,200 for family coverage, plus an extra $1,000 if you’re 55 and older.
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You can use the HSA money for eligible medical expenses at any time in the future — there’s no use-it-or-lose-it rule — and most HSA administrators let you invest the money in mutual funds until then, in addition to offering a savings account for short-term expenses. After age 65 you can withdraw the money for non-medical expenses without a 20% penalty and use it for whatever you want — but you will still have to pay taxes on the non-medical withdrawals. However, with Medicare premiums and other out-of-pocket expenses, you are likely to have plenty of eligible medical expenses that qualify for tax-free withdrawals.
You can increase the tax benefits even more by taking advantage of an interesting quirk of the HSA law: There’s no time limit for withdrawing the money for eligible medical expenses you incurred after you opened the HSA. For example, if you opened an HSA several years ago and pay $500 out of your pocket for prescription drug co-payments this year, you can withdraw that $500 from the HSA anytime in the future — even after several years have passed.
“Once you establish your health savings account, you can reimburse any qualified expense tax-free for the rest of your life,” Stuart said. “If you choose to pay expenses with post-tax dollars to preserve your health savings account balances, keep the receipts. In retirement, you can reimburse those qualified expenses with a tax-free withdrawal from your account.” Since you incurred the expense after you established the HSA, you can withdraw the money anytime in the future — helping to build up tax-free savings you can tap for any reason. “As long as the distribution is backed by receipts for qualified expenses that you could have reimbursed immediately from your health savings account but didn’t, the withdrawal is tax-free,” Stuart said.
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