Piecing together the Medicare and Medigap puzzle

I was doing some personal retirement planning the other day, and I was wondering how much out-of-pocket do Medicare beneficiaries typically spend? It would be nice to know average costs that do not include insurance premiums. This could help me decide if buying a Medicare supplement insurance policy or a Medicare Advantage plan is really as important as the purveyors say. (I can’t wait till I’m 64 and the offers start to overflow my mailbox! I am 62.) — S.S., Austin, Texas

That is a great question, but it is flawed. Knowing how much Medicare beneficiaries typically spend doesn’t deal with how much can be spent. Mitigating exposure to extreme events is what insurance is all about. What you will find is that the Medicare supplement policies start with premiums that get your attention and rise from there.

A 2013 Kaiser Family Foundation report indicated that the average monthly premium for Medigap policies was $183, with much variation around that average. The same report also noted that only 23 percent of Medicare beneficiaries have Medigap policies. So it appears that most retirees either don’t have the means to pay the premiums, or they have enough money that the risk of additional costs can be ignored. (Not likely.) The report also stated that the number of Medigap policies in force had declined from 9.5 million in 2006 to 9.3 million in 2010 — even as the number of retirees rose.

Just to add a little perspective, the average monthly Social Security benefit is now $1,294, from which the required premiums for Medicare Part B and Part D are subtracted. The Medicare Part B premium is now $104.90 a month for most people. (People with high incomes pay more.) The Medicare Part D base premium this year is $32.42 a month. Add the average Medigap policy premium of $183, and the total is $320.32 a month. That’s 25 percent of the average Social Security check.

Medicare Advantage plans (Medicare Part C) don’t cover “first dollar” expenses such as co-pays as the most popular Medigap policies do, but their monthly premium costs can be as low as $0. That’s a pretty big running start against that $183 per month average Medigap policy premium.

We are grandparents with $100,000 set aside for our three grandchildren’s college expenses. The first grandchild starts in the fall of 2015, the next starts three years later, in 2018. The third, another three years later, in 2021.

Our initial thought was to invest one-third in cash, one-third in bonds and one-third in stocks. Now our confusion begins. We are advocates of your low-expense investment advice. We don’t know what funds to invest in. And when the time comes, we don’t know how to make the funds available for withdrawal. We have other accounts in both Fidelity and Schwab. Any advice? — D.M., by email

The answer depends very much on whether you are willing and capable of making up possible losses if you take stock or bond market risk. If you program this out — as you appear to have done — you will be dispersing the full sum of money over a period of 10 years, starting one year from now. In addition, you’ll be dispersing nearly half of the money in five years.

This suggests that most of the money must be considered short-term investment, so you can’t rely on long-term returns to rescue you from a bad year or two in the stock market.

So here is my suggestion. If you can’t replace any losses, shop the CD market for certificates that will mature at the time needed. You might also explore CD-like term annuity contracts. That way you will be able to deliver the full $100,000 along with a small amount of interest.

If you can tolerate some losses and have the means to replace them, put half the money in a very short-term bond fund. Put the other half in a low-cost balanced fund such as Vanguard Balanced Index, Fidelity Puritan or Dodge and Cox Balanced. All three funds have very good long-term records and relatively low expenses.

Questions about personal finance and investments may be sent by email to scott@scottburns.com. Please visit www.assetbuilder.com to comment on any of his articles, find referenced Web links or to discuss personal finance topics on his forums. Questions of general interest will be answered in future columns and on the website.