When people work out how much they need to retire early, the spreadsheet usually starts with the big numbers: annual spending, investment returns, withdrawal rates and the size of the portfolio they’ll need.
Healthcare often gets a much smaller line, if it gets one at all – and that can be a problem.
Leaving work doesn’t mean your healthcare costs disappear. If anything, retiring early can make them harder to predict. You lose employer benefits, medical expenses can vary dramatically from one year to the next, and the income generated by your portfolio can affect decisions around private health insurance and tax.
For anyone pursuing financial independence and early retirement (FIRE), healthcare needs to be part of the plan from the beginning.
Your investment income could affect your Medicare Levy Surcharge
The Medicare Levy Surcharge (MLS) is an additional tax of 1%, 1.25% or 1.5% for people above certain income thresholds who don’t have an appropriate level of private patient hospital cover. It is charged on top of the standard 2% Medicare levy.
For someone still working, it can be relatively easy to estimate where their income will land. For an early retiree, it’s less straightforward. You might have stopped receiving a salary but still have investment income that pushes you over the relevant threshold.
For 2025-26, the base MLS threshold is $101,000 for singles and $202,000 for families, plus $1,500 for each dependent child after the first. The surcharge then increases through the 1%, 1.25% and 1.5% tiers.
The important point for investors is that MLS income isn’t necessarily the same as the amount of cash you’ve received from your portfolio. It can take into account:
- Taxable income, including investment income such as ETF distributions and net capital gains
- Reportable fringe benefits
- Net investment losses
- Reportable super contributions, including salary-sacrificed amounts
For an investor, distributions and capital gains are particularly relevant. An ETF can generate taxable income even if you haven’t sold any units. And because franking credits are grossed up, a portfolio with a large amount of Australian dividend income can have a higher income-for-MLS-purposes figure than the cash that actually landed in your account.
Capital gains can create a similar issue. You might normally sit below the MLS threshold, but sell a large parcel of ETFs in one financial year and the resulting taxable gain could push you over it.
That makes the timing of portfolio sales worth considering when you’re designing a drawdown strategy. Rather than assuming your income will be the same every year, model the years in which you expect to sell investments, rebalance the portfolio or receive larger distributions. You can then compare your potential MLS liability with the cost of appropriate hospital cover.
Dropping private health insurance can have a long tail
The MLS isn’t the only reason an early retiree might think twice about dropping private hospital cover. There’s also Lifetime Health Cover (LHC) loading.
Broadly, if you take out hospital cover after 1 July following your 31st birthday, you may pay an additional 2% on the base premium for every year you’re over 30. The loading is capped at 70%, applies to hospital cover rather than extras, and is removed after you’ve held hospital cover continuously for 10 years. So dropping cover can make your retirement budget look better in the short term while creating a potentially higher cost if you decide to take it up again later.
There are trade-offs either way.
Dropping cover means:
- Lower annual spending, which can reduce the amount you need to withdraw from your portfolio.
- Potential exposure to the MLS in years when your income is above the threshold.
- The possibility of paying a higher premium if you take out cover again and LHC loading applies.
- Greater reliance on the public hospital system, including its waiting times and restrictions around choice.
Keeping cover means:
- Another ongoing expense to include in your retirement budget.
- Premiums that are likely to rise over time.
- Maintaining your LHC position.
- Potential protection from the MLS when your income is high enough to trigger it.
The decision isn’t necessarily about which option is cheaper this year. If you’re planning for several decades of retirement, it makes more sense to run both scenarios through the plan and see what happens as premiums and other costs rise.
Don’t forget the costs that insurance doesn’t cover
Private hospital insurance and Medicare won’t cover every healthcare expense. There are GP and specialist costs, dental and optical bills, physiotherapy, prescriptions, hospital excesses and ambulance fees. Medicare and PBS safety nets can reduce some expenses once you reach the relevant thresholds, but they don’t eliminate them.
For a FIRE plan, it makes sense to give healthcare its own budget rather than burying it inside general household spending. That could include:
- A regular healthcare allowance for premiums, appointments, prescriptions and dental care.
- A separate assumption for healthcare inflation, rather than simply applying your general household inflation rate.
- A contingency amount for the years when something more expensive comes up.
You don’t need to predict exactly what your medical bills will be 20 years from now. The point is to make room for the fact that they won’t be the same every year.
Keep a buffer so you don’t have to sell in a downturn
One of the bigger risks is having a large medical expense arrive at exactly the wrong time. If markets have fallen and you suddenly need to sell investments to pay a medical bill, you could end up locking in losses. If the sale also creates a capital gain, it could affect your taxable income and potentially your MLS position.
A separate cash buffer can give you some breathing room. Some investors might choose to:
- Keep a cash or offset-account reserve for unexpected healthcare costs.
- Direct some dividends or other investment income into that reserve.
- Set a rule for rebuilding the buffer after it’s used.
How much you need will depend on your circumstances. Age, health needs, insurance arrangements and risk tolerance all make a difference. The original model uses 12 to 24 months of baseline healthcare costs as an illustration, rather than a recommended amount.
Put healthcare through the same stress test as the rest of your FIRE plan
A retirement plan can look very different once you stop assuming that every year will be an average year.
What happens if markets fall while you have a major medical expense? What if private health premiums increase more quickly than expected? What if you sell a large investment and end up over the MLS threshold?
Running those scenarios can show whether your planned withdrawal rate still works when several things go wrong at once. It can also highlight where you need more flexibility – whether that’s a larger cash buffer, a different approach to investment sales or a different decision around private hospital cover.
So, how should you approach FIRE planning?
Healthcare is an awkward expense to put into a FIRE plan because it’s difficult to predict. Some years might involve little more than routine appointments and prescriptions. Another might bring a major dental bill, specialist treatment or surgery. For early retirees, there are also tax and insurance decisions that don’t necessarily come up in a standard retirement calculation.
At a minimum, your model should account for:
- Medicare Levy Surcharge: Portfolio distributions and realised capital gains can affect whether you’re above the relevant income threshold.
- Private hospital cover: Compare the cost of premiums with potential MLS costs and the value you place on private care.
- Lifetime Health Cover: Dropping cover can have consequences if you decide to return to private insurance later.
- Out-of-pocket costs: Medicare and private insurance won’t cover everything.
- A healthcare buffer: Cash set aside for medical expenses can reduce the chance of having to sell investments during a market downturn.
- Tax-efficient drawdowns: The timing of investment sales and distributions can affect both your tax bill and your MLS position.
Healthcare probably won’t be the most interesting part of your FIRE spreadsheet, but if you’re planning to spend 30 or 40 years living off your investments, it’s too significant to leave in the miscellaneous column.
Disclaimer: This article is general in nature and has been prepared without taking into account your individual objectives, financial situation or needs. It does not constitute financial, tax, insurance or superannuation advice, and nothing in it should be relied upon as a recommendation to buy, hold or sell any financial product or change your investment or insurance strategy. Tax and private health insurance outcomes can vary depending on your individual circumstances. Before making decisions about your investments, tax, superannuation or private health insurance, consider whether the information is appropriate for you and seek professional advice from a qualified financial adviser, registered tax agent or your health insurer.
