For most retirees, healthcare is often the single largest and hardest-to-predict cost in retirement, sometimes totaling hundreds of thousands of dollars over a lifetime. Healthcare funding can come from a variety of sources, but Medicare — the federal health insurance program — plays a central role in retirement financial planning. Despite how important it is, many Americans find Medicare’s rules confusing and difficult to navigate.
Understanding how Medicare works, what choices it offers, and how those choices fit into a broader financial plan is essential for retirees and those getting close to retirement. Making the right decisions can help protect your savings, get the most out of your health coverage, and keep your cash flow steady throughout what could be decades of retirement.
Why Medicare is so important
Medicare became law when President Lyndon B. Johnson signed it on July 30, 1965. It originally included Part A (Hospital Insurance) and Part B (Medical Insurance), which together are called Original Medicare. Over the years, Congress expanded the program to cover more people and offer more benefits, including coverage for prescription drugs. Today, Medicare provides health coverage for more than 68 million Americans — about 61 million people aged 65 and older, plus around 7 million younger people with disabilities.1
Medicare has become even more important as healthcare costs have continued to rise. According to the Centers for Medicare and Medicaid Services, national health spending in 2024 reached about $15,474 per person, making up 18% of GDP (the total value of goods and services produced in the country). Over the next ten years, healthcare spending is expected to grow even faster than the overall economy. For retirees — many of whom rely on a fixed income — Medicare provides critical financial protection against these rising costs.
The program is currently divided into four parts:
• Part A covers hospital stays, skilled nursing facilities, and hospice care. Most people do not pay a monthly premium for Part A if they have worked for at least ten years.
• Part B covers visits to doctors, outpatient care, and preventive services. It requires a monthly premium that can be higher for people with higher incomes.
• Part C, known as Medicare Advantage, is offered by private insurance companies as an alternative to Original Medicare. It often includes extra benefits like dental, vision, and hearing coverage.
• Part D provides optional coverage for prescription drugs through private insurers and may also cost more for higher-income individuals.
A common misunderstanding is that Medicare is entirely free because people have paid into it through payroll deductions throughout their working years. While Part A is indeed free for most people, Part B premiums, supplemental coverage, and other out-of-pocket costs can add up quickly. That is why it is so important to factor Medicare into a complete financial plan.
The Medicare income cliff: Why planning around IRMAA matters
One of the biggest Medicare surprises that catches retirees off guard is IRMAA. This is an extra charge added to Medicare premiums which kicks in if you earn more than $109,000 as an individual or $218,000 as a married couple filing jointly. These amounts are for coverage year 2026 and are adjusted annually.
IRMAA stands for Income-Related Monthly Adjustment Amount. It is an extra fee added to your Medicare Part B and Part D premiums if your income is above certain levels. Unlike regular tax brackets — where only the income above a certain point gets taxed at a higher rate — IRMAA works like a cliff. If your income goes above a threshold by even one dollar, you pay the full extra charge for that entire bracket. This can catch even well-prepared retirees off guard if their income unexpectedly rises.
What makes this even more complicated is that IRMAA is based on your income from two years earlier, since that is the most recent tax filing available. For example, the surcharge you face at age 65 is determined by your income from the year you turned 63. This two-year lookback means that financial decisions made well before you enroll in Medicare — such as converting savings to a Roth IRA, selling investments for a gain, or deciding when to start collecting Social Security — can affect how much you pay for Medicare coverage.
It is also worth knowing that the income thresholds for IRMAA and regular IRS tax brackets are different. A common tax planning strategy is to take on a bit more income — such as by converting money to a Roth IRA — to “fill up” a tax bracket. But doing this without also checking IRMAA thresholds could accidentally push you over a cliff, leading to hundreds or even thousands of dollars in extra annual premiums.
There are several strategies that may help reduce IRMAA exposure. Qualified Charitable Distributions, for example, allow retirees to donate their Required Minimum Distributions (the minimum amount the government requires you to withdraw from certain retirement accounts each year) directly to charity. This approach does not increase your taxable income, unlike standard charitable deductions, which reduce taxes but do not lower the income figure used to calculate IRMAA. Timing Roth conversions at least two years before enrolling in Medicare can also be helpful, since that income will fall within the lookback period before surcharges kick in.
Delaying Social Security is another factor to consider, and it cuts both ways. Waiting to collect Social Security reduces your current income, which can help you stay under IRMAA thresholds in the near term. However, the larger payments that come from delaying could coincide with Required Minimum Distributions later in retirement, potentially pushing your income above surcharge levels in future years. These trade-offs are exactly why retirement income planning needs to be coordinated and thought through over multiple years.
Medigap vs. Medicare Advantage: Choosing the right coverage
Besides income planning, another key decision retirees face is choosing between Medigap (also called Medicare Supplement Insurance) and Medicare Advantage. This choice is shaped not only by your healthcare needs but also by how much financial risk you are comfortable with in retirement. From a planning standpoint, it comes down to your tolerance for uncertainty, your lifestyle, and how predictable you want your healthcare costs to be.
Medigap works alongside Original Medicare (Parts A and B) to help pay for costs that Medicare does not fully cover, such as deductibles (the amount you pay before insurance kicks in), coinsurance (your share of costs after the deductible), and copayments (fixed fees for specific services). Monthly premiums are higher — roughly $32 to $550 depending on the plan and where you live — but your out-of-pocket costs tend to be lower and more consistent.
Medicare Advantage, on the other hand, is designed to serve as a full replacement for Original Medicare. These plans are sold by private insurance companies and often bundle in extra benefits like dental, vision, and hearing care. The monthly premiums are often low, which makes them appealing at first. However, they typically come with higher out-of-pocket costs (though there is an annual cap), restrictions on which doctors and hospitals you can use, and requirements to get referrals for specialist care. It is also important to know that switching back to a Medigap plan later in life may be difficult or even impossible due to medical underwriting, meaning insurers can consider your health history when deciding whether to cover you.
Medigap offers higher fixed monthly costs but more predictable total healthcare spending — similar to paying more upfront for more complete coverage. It also covers care anywhere in the country, which matters for retirees who plan to travel frequently. Medicare Advantage offers lower upfront costs but introduces more unpredictability in how much you spend on healthcare each year, particularly for people with ongoing health conditions or unexpected medical needs.
For retirees who have built up significant balances in Health Savings Accounts (tax-advantaged accounts used to pay for medical expenses) or other dedicated healthcare funds, the variable costs of Medicare Advantage may be manageable. For those who value budget certainty or who need frequent medical care, the more predictable costs of Medigap may be worth the higher premium. In 2025, the average Medicare beneficiary had 42 Medicare Advantage plans to choose from, which highlights how important it is to carefully compare your options every year.
Keeping up with your circumstances and policy changes
Medicare planning is not something you do once and forget. It requires an annual review because plans, premiums, your health, and your income can all change from year to year. It is also important to stay aware of any policy changes, such as updates to IRMAA thresholds. Unlike more straightforward financial goals — such as saving for a child’s education — healthcare costs are unpredictable and tend to grow as you age, making regular adjustments a necessary part of any retirement plan.
A few additional things to keep in mind:
• Timing is critical. Missing the Initial Enrollment Period — a seven-month window centered around your 65th birthday — can result in a permanent 10% penalty on Part B premiums for every year you delay enrolling, unless you qualify for a Special Enrollment Period because you are still working and covered by an employer’s health plan.
• Limited long-term care coverage. One fact that surprises many people is that Medicare covers only limited long-term care — such as a stay in a skilled nursing facility — under specific circumstances, like following a qualifying hospital stay for a condition that is expected to improve. It does not cover ongoing custodial care, such as help with daily activities.
• Life events can impact costs. Major life changes — such as losing a job, going through a divorce, or the death of a spouse — can trigger a review of IRMAA surcharges. If your income drops as a result, you may be able to pay lower premiums.
When approached thoughtfully, Medicare can be a powerful tool for building a more secure and predictable retirement. The key is to plan ahead and take the time to understand the rules before you need to make decisions.
The bottom line? Medicare decisions have wide-ranging effects on your retirement income, taxes, and overall financial plan. Understanding how the program works, planning carefully around income thresholds, and selecting the right coverage are all essential steps to protecting your savings and maintaining your financial wellbeing throughout retirement.
References
1. https://data.cms.gov/summary-statistics-on-beneficiary-enrollment/medicare-and-medicaid-reports/medicare-monthly-enrollment
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