Understanding How Medicare Part D Drug Plans Work

30 minute read| Updated for September, 2020

What is Medicare Part D?

Medicare Part D addresses the high costs of prescription drugs by authorizing private insurance companies to create and offer prescription drug plans (PDPs) for Medicare-eligible Americans. Part D first became effective in 2006.

Medicare enrollees can obtain drug coverage through standalone prescription drug plans, or through Medicare Advantage plans. In more limited situations, drug coverage is available through Medicare Cost plans.

To be eligible for a Part D prescription drug plan, you must meet one of the two following criteria:

  • You must be eligible for Medicare Part A (even if not actively enrolled), or
  • You must be enrolled in Medicare Part B

In order to be eligible for a Medicare Advantage plan with prescription drug coverage (MAPD), you must be actively enrolled in both Part A and B.

In order to prevent people from signing up for drug coverage only when they really need it, Part D requires you to enroll as soon as you are eligible.

How Much Does Medicare Part D Cost?

The cost for Medicare Part D varies according to the specific plan you enroll in, as does the coverage that each plan offers. Generally, you can expect to pay the following types of costs for a standalone prescription drug plan:

  • Monthly premium
  • Annual deductible (up to $435 for 2020)
  • Copayments or coinsurance for each prescription filled (known as cost-sharing)

Most Medicare Part D plans have a monthly premium, although some are available with no premiums. Many also have a deductible, meaning that you pay the full cost for prescriptions until you have reached the set deductible. Then, from that point onward, the plan begins covering part of the cost for your medications.

The price you pay for prescriptions is based on the two following items:

  • The “Tier” the medication is in, and
  • Which “Coverage Stage” you fall within

What Are Medicare Part D Drug Tiers?

Every Part D drug plan must have a formal list of the medications that it covers. This list is known as a formulary. Within the formulary, all the drugs are categorized by tiers, which range from 1 to 4. The higher the number of tier, the more expensive the drug  is. The four tiers are organized as follows:

  • Tier 1 drugs – preferred generic medications
  • Tier 2 drugs – non-preferred generic medications
  • Tier 3 drugs – preferred brand name medications
  • Tier 4 drugs – non-preferred brand name and specialty mediations

Drug plans can save people who need a lot of medications quite a bit of money, especially during the coverage gap stage.

What Are Part D Coverage Stages?

The amount you pay for a covered drug can change during the course of the year. In other words, the price you pay for a Tier 3 medication in December can be different from the price that you pay for the same drug in January.

The price can change based on how much you and your plan have spent on drugs during the year. As you and your plan pay more, you move through the four coverage stages:

  • First stage — deductible stage: You pay full price on all drugs until you have met the plan deductible (no more than $435 for 2020). Many plans do not have a deductible, so you start the year in Stage 2.
  • Second stage — Initial coverage stage: In this stage, you pay the plan-specified copayment or coinsurance for each prescription (based on the tiers). You exit this stage once you and your plan have spent $4,020 during the year, and then you move into the third stage.
  • Third stage — coverage gap stage: During the coverage gap stage (also known as the donut hole) you pay 25% of the discounted cost for name brand drugs and 25% of the cost for generics. You stay in the coverage gap until your total costs reach $6,350 (including manufacturer discounts), and then you move into the fourth 
  • Fourth stage — catastrophic coverage stage: In the catastrophic stage, your costs are very small; no more than 5% of the retail cost of each drug.

The coverage stages reset after December 31, and on January 1, you start back at the first stage. There is no out-of-pocket limit on the amount you can spend on drugs each year.

What is the Part D Donut Hole?

The Medicare donut hole is the nickname used to describe the coverage gap stage. The donut hole got its name from the fact that when an enrollee used to enter the third coverage stage, they would become responsible for a large portion of the cost of medications. As such, there appeared to be a hole in their coverage.

However, this “donut hole” was closed in the beginning of 2019. Specifically, this gap in drug benefits was closed by requiring name brand drug manufacturers to provide hefty discounts to Part D plan members in the coverage gap stage.

Is Medicare Part D Worth It?

The idea of having to pay for a plan that has something called the “catastrophic coverage stage” can understandably be somewhat scary. As such, you may wonder if having Part D coverage is worthwhile.

There are two compelling reasons to have prescription drug coverage along with your Medicare insurance:

  • You will pay a late enrollment penalty if you do not enroll on time, but later decide that you want or need coverage
  • If you have Part D coverage, you receive large discounts on brand name drugs when you need it most

In order to prevent people from signing up for drug coverage only when they really need it, Part D requires you to enroll as soon as you are eligible. Otherwise, you will pay a penalty in the form of a higher monthly premium. This penalty is based on the total number of months your enrollment is late. If you wait for years to enroll, your penalty could be a substantial sum.

On a more positive note, drug plans can save people who need a lot of medications quite a bit of money, especially during the coverage gap stage.

During this stage, Medicare covers 75% of the costs for generic drugs. Also, brand name manufacturers discount their prices by 70% during this coverage stage. Your plan covers 5%, and you pay the remaining 25% of the cost for brand name drugs.

While there are programs that help with the cost of drugs, you may not qualify for them if your income is too high. However, you can still access them through your Medicare Part D coverage. Even if you do not take any prescription drugs, it is still worth enrolling in a plan to avoid paying a penalty later. You can always enroll in a plan with a very low premium, just to meet the requirement.

As you get close to the time for entering Medicare, it is a good idea to learn as much as you can about the program and its benefits.

When Can You Sign Up for Part D?

Whether you want to enroll in a standalone drug plan or a Medicare Advantage plan with drug coverage, you will have the opportunity to do so when you first enroll in Medicare. For most people, this occurs when you turn 65.

When you first turn 65, you will enter your Initial Enrollment Period (IEP). Your IEP lasts seven months and spans the following time periods:

  • Three months before the month of your 65th birthday
  • The month you turn 65
  • Three months after you turn 65

At any point in time during this window, you can enroll in either a standalone drug plan or a MAPD plan.

How Do You Move Forward With Part D?

As you get close to the time for entering Medicare, it is a good idea to learn as much as you can about the program and its benefits. You’ll want to decide whether you need a standalone Part D plan, or figure out if a Medicare Advantage plan with drug coverage is best for you.

It is always wise to compare quotes for any plans that you are interested in, while making sure that they cover your preferred doctors and any drugs that you are currently taking.