Under the Hood: Medicare Premiums—What You Need to Know, Pt. 2

In the initial post in this two-part series looking Under the Hood on Medicare, Medicare Parts A, B, C and D—What You Need to Know, we presented a primer on the four different parts of the Medicare system and their origins, growth, options and costs.

This week we'll focus on Medicare premiums, which I believe are quickly becoming an integral part of the financial planning process; each advisor should have at least a cursory understanding of the cost of the program.

Medicare Part A Premiums

As mentioned, this part of Medicare covers inpatient hospital, skilled nursing care, and nursing home and hospice care, within limits. Moreover, it is free to those who qualify for Medicare (i.e.; paid into Medicare for at least 10 years). This includes a spouse of those who have paid into Medicare, even if the spouse hasn't paid into the system.

If an individual is not eligible for free Part A, they may still purchase it by paying a premium up to $426 per month. Moreover, if you don't qualify for free Part A, and you don't buy it when you first become eligible, you may be subject to a penalty equal to a 10% increase in the monthly premium.

For example, if you were eligible for Part A two years ago and you enroll today, you would pay the higher premium for two times the period for which you were eligible but not enrolled. Hence, the higher premium would last four years. There are, however, some exceptions which are beyond the scope of this article.

One final note on Part A. If you choose to buy Part A you must also purchase Medicare Part B.

Part B Premium

This is the portion of Medicare which covers outpatient services and is optional. It should be noted that your premium for Part B will be based, in some cases, on your income from as many as two years. For example, if you became eligible for Medicare in March 2014 and enroll in Part B, assuming you hadn't filed your 2013 tax return by then, Medicare would use your income tax return from 2012 to determine your premium. Hence, if your retirement income is much lower than your income while working, your Part B premium may cost you more than you anticipated.

The premium is based on income and, just like Medicare Part A, if you fail to enroll in Part B when first eligible and do not have a valid exception (again beyond the scope of this article), you may be subject to a penalty which is much more onerous than the penalty from Part A.

In short, the penalty is a 10% premium increase for each full 12-month period you are late in enrolling. Hence, if you were 38 months late (three full years plus two months), your premium will be 30% higher for as long as you have Part B.

The following table displays the cost of Medicare Part B and Part D which we'll discuss in the next section.

Medicare Part B & Medicare Part D Premiums

Part D Premium

This part of Medicare covers prescription drugs and is available to anyone eligible for Medicare. In my last post on Medicare I included a link to the Medicare Plan Finder. This tool will allow you to select the Part D plan which suits your needs. As mentioned, one way to purchase this coverage is through a Medicare Advantage plan under Medicare Part C. Refer to the table above for the monthly premium. According the Medicare, most people won't have to pay a higher premium for Medicare Part D.

Medicare Changes From the Affordable Care Act

With the implementation of the Affordable Care Act, aka Obamacre, several preventative medical procedures are now covered under Medicare with no deductible or coinsurance. These include items such as mammograms, colonoscopies, cancer screenings and yearly "Wellness" visits. In addition, there are lower prices on many covered brand-name drugs.

Another change affected by the Affordable Care Act has to do with the so-called prescription drug "donut-hole." Since Medicare Part D covers up to $2,970 per year for prescription drugs, an individual will pay a co-pay of 47.5% for brand name drugs and 79% on generics when their total prescription drug bill exceeds the annual maximum. This gap will be closed by the year 2020. After that, individuals will pay a flat 25% for all prescriptions, brand name or generic.

If you have a Medicare Advantage plan, you may experience some differences between it and original Medicare (some better, some worse). Under the ACA, Medicare will be paying less to some Medicare Advantage plans. As a result, some plans may cut benefits such as dental care or increase coinsurance requirements. You should check with your particular Medicare Advantage plan for details.

Finally, prior to the new law, when a patient had a surgical procedure, each medical practitioner involved would send a bill for their services. This is known as a fee-for-service model. Under the new law, the payment will be bundled. The expectation is that a bundled system will help reduce waste and unnecessary charges as each "episode of coverage" will be reimbursed according to a pre-determined schedule. Will this work as planned? We shall see.

Future Viability of the Program

Medicare is one of the largest items in the federal budget with projected costs expected to reach $858 billion by 2024. That equates to about 30% of today's federal revenue. Therefore, unless we grow our economy (which would increase tax revenue), we may be looking at a hefty tax hike down the road.

That is, unless Washington takes some sort of action such as raising the Medicare withholding tax percentage or the age of eligibility.

In general, this entitlement is only one of many which cause economists to worry that we are on a fiscally unsustainable path. According to one Federal Reserve President with whom I spoke recently, the current fiscal deficit is improving. However, it will begin expanding around 2020 when entitlements will cause stress to the budget.

For more information, you can download the official 2014 Medicare handbook Medicare & You." This 152-page book has everything you need to know about the program.

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Check out Medicare Parts A, B, C and D—What You Need to Know on ThinkAdvisor.

View the entire Under the Hood series of articles.