Health Care for Independent People: Part 1

For anyone who wants to live outside the confines of regular employment, one of the biggest questions is, "What about health insurance?" This question is so big and scary that many resources on early retirement pretend it doesn't exist, or simply say, "You must have health insurance," as though it's a given.

Back in March, I laid out my rough plan for becoming financially independent by sometime in my thirties. I also examined how a potential child could affect my budget. Today, it's time to tackle healthcare.

The traditional solution to post-retirement healthcare is Medicare. There’s a heck of a long time between 35 and whatever-astronomical-age-I’ll-become-eligible-for Medicare, and I'm not overly confident that it will exist in a form like it does today by the time I get there. So for the purposes of this post, Medicare isn't a factor.

The first pillar of my healthcare plan, and one I would recommend to anyone who's planning to live without employer-sponsored health insurance, is to self-insure for routine medical expenses like maintenance prescriptions and annual physicals. The premiums for health insurance that covers these expenses are often astronomical, as we'll see in part two of this series. For many people, it will be far cheaper to pay these routine costs out of pocket.

At my current level of health, I would expect to pay about $1700 annually for health maintenance. This covers my two current prescriptions, which would cost about $105 a month, a yearly physical with blood work and a pap smear, which according to the bill from my doctor would have cost $359 without insurance, and perhaps a second doctor's visit for a straightforward health problem, which would cost about $150. These costs should be built into my baseline post-retirement budget.

I would also plan to "self-insure" (meaning I would pay out of pocket) any healthcare cost under $10,000. This would cover minor but less routine costs like some emergency room visits, extra tests, and minor injuries. I'd put about a third of this in a Health Savings Account, currently capped at $2850 in contributions per year. This account functions like a Roth IRA--money is taxed when you put it in, but is not taxed when you take it out. For long-term savings, this is an excellent deal, since the interest on your savings can far exceed the initial contributions. Unlike a Roth IRA, there are no age limits on when money can be used. Eventually, the HSA would become large enough to contain all of my self-insurance money. For the first few years, I'd put the balance of the $10,000 in a liquid and low-risk investment, like a high-yield savings account.

Even with a large amount of money set aside for self-insurance, major medical events like surgery or cancer can be catastrophic. Cancer treatment can cost $300,000 a year. Young people may get away with not having insurance for short periods of time (I have, and am none the worse for it), but any long-term budget must include some form of health insurance. What are the options for getting health insurance on your own? How much does it cost? We'll start exploring this in Health Care for Independent People: Part 2

IRA Hacks: 72(t) and the Spousal IRA

Two little-known ways of using IRAs can be useful to early retirees or potential early retirees, stay-at-home parents, or anyone who’s not working but has a working spouse.

[Disclaimer: The following should not be considered financial advice. I have only a rudimentary knowledge on these subjects. Comments and corrections are appreciated.]

The “Spousal IRA”

In order to contribute to an IRA, your qualifying income for that tax year must be equal to or greater than your IRA contributions. So if you earned $3,000 in 2007, you could not contribute the maximum of $5,000 to your IRA. But if you’re married and your spouse is working, your spouse can contribute to your IRA up to the maximum.

This is occasionally referred to as a “spousal IRA,” but it’s not a separate type of account. If you already have an IRA from your working years, your spouse can contribute to that account, and if you need to open up a new account for this, it’s simply a regular IRA account. You must file your taxes jointly.

The most obvious use for this is so that stay-at-home parents can save for retirement. But I can also see this type of contribution being helpful for couples with a whole spectrum of other situations--couples in which one partner has retired early, is making only minimal income from a part-time job, is trying to start a new business (but not making a profit yet), or is unemployed/taking some time off. It allows a married couple to take full advantage of the perks of IRAs even though one of them may not have a job.

The 72(t) Rule

I don’t know why the 72(t) rule isn’t better-known. Even in the online early retirement community, people don’t seem to talk about it much. I think it’s so cool I can hardly believe it’s real—you mean I get to keep my money in a tax-sheltered account and I can get at it before I qualify for AARP?

Rule 72(t) allows you to take money out of an IRA without penalty before age 59 ½ as long as the withdrawals are made in “substantially equal periodic payments” (SEPP). The SEPPs must for at least five years or until you reach age 59 ½, whichever is longer. The rules governing exactly how much you can take out in each payment are fairly complicated, and there are a couple of different ways of calculating it—the IRS can tell you more (You might also try googling “72t calculator,” but I’m not familiar enough with these to recommend one here.)

The few things I've found in print about 72(t) seem to think that the SEPPs are a big drawback. I don't see why they would be. If you're on top of your finances enough to have retired early, you probably have a very clear idea of what you spend and can estimate pretty well how much you want each month and how it could change. With the limited amount of money one can put into an IRA, it’s unlikely that this would be your sole source of cash flow.

Now, clearly, if you don’t have a very solid plan for how you’re going to finance your golden years, taking SEPPs would be really dumb. But if you've got your post-65 life covered through your 401(k), IRA, or other investments and sources of income, and want to retire early, 72(t) allows you to free up some money without paying penalties.