For most retirees, healthcare is one of the biggest and hardest-to-predict costs in retirement — often totaling hundreds of thousands of dollars over time. Healthcare can come from many sources, and Medicare (a federal health insurance program primarily for people 65 and older) is one of the most important pieces of the financial planning puzzle. Even so, Medicare's rules can be confusing for many people.
Knowing how Medicare works, what decisions it requires, and how those decisions fit into your overall financial plan is critical for retirees and those getting close to retirement. Making the right choices can help protect your savings, make the most of your health coverage, and manage your spending throughout retirement.
Why Medicare matters today
Medicare was signed into law by President Lyndon B. Johnson on July 30, 1965. It originally had two parts: Part A (Hospital Insurance) and Part B (Medical Insurance), which together are called Original Medicare. Over time, Congress has expanded the program to cover more people and offer more benefits, including prescription drug coverage. Today, Medicare provides health coverage for over 68 million Americans — about 61 million people aged 65 and older, and 7 million younger individuals with disabilities.1
Medicare has become increasingly important as healthcare costs have continued to rise. According to the Centers for Medicare and Medicaid Services, national health spending grew to roughly $15,474 per person in 2024, making up about 18% of the country's total economic output (GDP). Over the next ten years, healthcare spending is also expected to grow faster than the overall economy. For retirees, many of whom rely on fixed incomes, Medicare provides important financial support against these rising costs.
The program is currently divided into four parts:
• Part A covers inpatient hospital stays, skilled nursing care, and hospice care. Most people don't pay a monthly premium for Part A if they have worked for at least ten years.
• Part B covers doctor visits, outpatient care, and preventive services. It requires a monthly premium that can be higher depending on your income.
• Part C, known as Medicare Advantage, is an alternative to Original Medicare offered by private insurance companies. 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 depending on your income.
A common misunderstanding is that Medicare is entirely free because workers have paid into it through payroll deductions over the years. While Part A is indeed free for most people, Part B premiums, supplemental (extra) coverage, and out-of-pocket costs can add up to a significant amount. This is why it's so important to factor Medicare into a well-rounded financial plan.
The Medicare income cliff: Why IRMAA planning 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, and it affects how much you pay for Medicare Part B and Part D. Unlike the standard income tax system — where only the income above each level is taxed at a higher rate — IRMAA works like a cliff. This means that if your income goes over 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 trickier is that IRMAA is calculated each year based on your Modified Adjusted Gross Income (MAGI) — essentially your total income with certain deductions added back — from two years earlier, since that is the most recent tax filing available. For example, the surcharge you face at age 65 is based on your income from the year you turned 63. This two-year lookback means that financial decisions made years before you enroll in Medicare — such as converting retirement savings to a Roth IRA, selling investments for a gain, or the timing of when you start Social Security benefits — can all have an impact.
It's also worth knowing that the income thresholds for IRMAA are different from the standard IRS income tax brackets. A common tax-planning strategy is to recognize extra income — such as converting money to a Roth IRA — to "fill up" a tax bracket. However, doing this without also considering IRMAA thresholds can accidentally push you over a cliff, resulting in hundreds or even thousands of dollars in additional annual premiums.
There are several strategies that can help limit IRMAA exposure. Qualified Charitable Distributions, for example, allow retirees to send their Required Minimum Distributions (the minimum amount the IRS requires you to withdraw from certain retirement accounts each year) directly to a charity. This keeps those amounts out of your income calculation, unlike standard charitable deductions, which reduce taxes but don't lower your MAGI. Timing Roth conversions at least two years before enrolling in Medicare can also help, since that income would fall in the lookback period before surcharges begin.
Delaying Social Security is another factor that cuts both ways. While it reduces your current income and can help you stay below IRMAA thresholds in the near term, the higher monthly payments you receive by waiting could overlap with Required Minimum Distributions later in retirement, potentially pushing your income above surcharge levels in future years. These trade-offs are exactly why managing income in retirement requires a coordinated, multi-year approach.
Medigap vs. Medicare Advantage
Beyond income planning, another important 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 uncertainty you're comfortable with in retirement. From a financial planning standpoint, it comes down to your risk tolerance, lifestyle, and how predictable you want your costs to be.
Medigap works alongside Original Medicare (Parts A and B) to help cover out-of-pocket costs like deductibles, coinsurance, and copayments. Monthly premiums are higher — ranging from roughly $32 to $550 per month depending on the plan and where you live — but your out-of-pocket costs tend to be lower and more predictable.
Medicare Advantage, on the other hand, can serve as a full replacement for Original Medicare. These plans are offered by private insurance companies and often include dental, vision, and hearing benefits. Premiums are frequently low, which makes them appealing at first. However, they typically come with higher potential out-of-pocket costs (though there are annual caps), network restrictions that limit which doctors and facilities you can use, and referral requirements that could result in denied care in some cases. It's also important to know that switching back to a Medigap plan later may be difficult due to medical underwriting, a process where insurers review your health history before approving coverage.
Medigap offers higher fixed monthly costs but more predictable total spending — similar to paying a higher insurance premium for broader coverage. It also offers coverage anywhere in the country, which is especially valuable for retirees who travel frequently. Medicare Advantage offers lower upfront costs but introduces more variability in annual healthcare spending, particularly for those with ongoing health conditions or unexpected medical needs.
For retirees with significant Health Savings Account balances or other dedicated healthcare funds, the variable costs of Medicare Advantage may be manageable. For those who prefer budget certainty or have health conditions requiring frequent care, Medigap's predictability 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 review options each year.
Monitoring personal circumstances and policy updates
Medicare planning is not a one-time event. It requires an annual review because available plans, premiums, your health situation, and your income can all change from year to year. It's also important to stay informed about any policy changes, such as adjustments to IRMAA thresholds. Unlike more predictable financial goals — such as saving for college — healthcare expenses are variable and tend to increase as you age, making ongoing adjustments a necessary part of any retirement plan.
Additional considerations 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, unless you qualify for a Special Enrollment Period through active employment.
• Limited long-term care coverage. One fact that surprises some people is that Medicare only covers long-term care (such as nursing home care) in limited situations — for example, after a qualifying hospital stay and admission to a Medicare-approved skilled nursing facility for a condition that is expected to improve.
• 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 reassessment of IRMAA surcharges, which could lower your premiums if your income decreases.
Navigating Medicare well can support a more secure and predictable retirement. The key is proactive planning — making sure you understand how to manage the complexities well before they arise.
The bottom line? Medicare decisions have far-reaching implications for retirement income, taxes, and overall financial planning. Understanding the program's structure, planning around income thresholds, and choosing the right coverage are essential steps to help protect savings and maintain financial health throughout retirement.
References
1. https://data.cms.gov/summary-statistics-on-beneficiary-enrollment/medicare-and-medicaid-reports/medicare-monthly-enrollment