Retirement Planning Strategies to Avoid Higher Medicare Premiums
When planning for their clients’ retirement, most financial advisors tell their clients to utilize 401(k) accounts and IRAs to accumulate as much as possible in these tax-deferred accounts. Allowing these accounts to grow tax-deferred is a great way to save for a person’s secure retirement. However, accumulating a large 401(k) or IRA can come along with some unexpected consequences for clients during their retirement years. One of those unexpected consequences can be higher Medicare premiums when clients start taking large distributions from their IRA accounts, especially after turning age 70-1/2, when they are met with taking RMDs (or required minimum distributions) from their IRAs.
Medicare charges premiums to participants in Medicare Part B, which covers doctor visits, and Part D, which covers prescription drug benefits. In 2018, the basic Medicare premium for Part B coverage was $134 per month, while the premium for Part D coverage varied depending on the prescription plan chosen. However, the Medicare premium charged to “high-income” individuals is substantially more than the basic $134 per month amount. “High income” in this area of the tax law is defined as those taxpayers with MAGI (modified adjusted gross income) of more than $85,000 on the tax return of a “single” person or more than $170,000 on the tax return of a couple filing as “married filing jointly”. For these “high-income” taxpayers, their Medicare premiums are subject to a surcharge known as an Income Related Monthly Adjustment Amount, or IRMAA for short. As the adjusted gross income on your income tax return continues to climb, the amount of the IRMAA (i.e., surcharge) continues to get larger. In 2018, for example, the largest premium surcharges applied to persons with MAGI over $160,000 on a single return or $320,000 on a married filing jointly return. For Medicare Part B, the largest surcharge is $294.60 per month which increases the monthly Medicare premium from the basic amount of $134 per month up to $428.60 per month, 3.2 times larger than the basic premium. For Medicare Part D, the largest surcharge is $74.80 per month. Combined, the surcharges for both Medicare Part B and Part D can total $369.40 per month ($294.60 + $74.80).
What’s New in 2019?
In 2019, a new additional income level of “over $500,000 single or $750,000 joint” will apply. IRMAA surcharges apply on a “cliff” basis. Reaching the first dollar of an IRMAA income level causes the full corresponding surcharge to apply to all premiums paid for the year.
Possible Strategies to Avoid Higher Medicare Premiums
Try to control your MAGI to minimize the Medicare surcharges. For IRMAA purposes, MAGI is defined as Adjusted Gross Income (AGI) with adjustments for some income that is exempt from federal tax, such as interest from state and local bonds (i.e., municipal bond interest). Medicare uses the MAGI reported on the federal tax return from two years ago in setting your Medicare premiums for the current year. For example, to determine whether someone will pay higher premiums for 2018, Medicare uses 2016 MAGI.
Utilizing Roth IRA Conversions may help to minimize income in retirement years. Roth IRA conversions can help to reduce IRMAA surcharges during your retirement years as distributions from Roth IRAs are considered tax free, which can help to reduce your MAGI. However, making a large Roth IRA conversion in one year could push you into a higher income tax bracket for that year of conversion. Instead, you may want to consider making a series of partial conversions over a number of tax years to keep you in a lower tax bracket for each year.
Consider using Health Savings Accounts (HSAs) in early years. Younger clients may want to consider funding an HSA, if they have a choice. You could make a deductible HSA contribution in your working years, then access your HSA tax and penalty free to pay for qualified medical expenses in retirement. These qualified distributions for medical expenses in retirement are not included in MAGI for purposes of determining Medicare premiums.
Qualified Charitable Distributions (QCDs) may also be used to minimize income. For older clients (over the age of 70-1/2), QCDs may also be used to help reduce MAGI and, thereby, Medicare premiums. Under the new tax law passed in December 2017, the standard deduction amounts have been increased whereby many clients will not receive any benefit from their charitable contributions because they will not be itemizing their deductions but taking the standard deduction instead. With a QCD, an IRA owner who is age 70-1/2 or older can transfer up to $100,000 annually from their IRA to a charity tax free. A QCD can satisfy an IRA owner’s RMD for the year, and the RMD is never included in income at all, so it is not included in MAGI.
If you have any questions about utilizing strategies to help reduce your Medicare premiums, please contact any of the financial advisors at DHJJ Financial Advisors by calling 630-420-1360 or filling out the form below.