Over the years, many have expressed great frustration about Medicare premiums and the surcharges that apply when taxable income exceeds certain levels. The following are some strategies to reduce the impact of these surcharges that may especially be interesting to those that are recently retired or soon to retire with large Individual Retirement Account (IRA) or qualified plan balances.
First, some background. Medicare charges a premium for participation in Medicare Part B, which covers doctor visits, and Medicare Part D, which covers prescription drugs. For 2018, the standard premium for Part B is $134 per month, while the premium for Part D depends on the plan elected. Individuals with “high income” pay more. “High income” here means modified adjusted gross income (MAGI), i.e., federal taxable income adjusted for certain tax-free income, in excess of $85,000 single and $170,000 married filing jointly. If someone has income above these levels, the Parts B and D premiums are subject to a surcharge called an Income Related Monthly Adjustment Amount, or IRMAA for short.
The amount of the IRMAA is currently set in four tiers above the base in which no surcharge applies. The four tiers above the base apply at incomes of $85,001, $107,001, $133,501, and $160,201 (single), and $170,001, $214,001, $367,001 and $320,001 (joint). For example, someone in the highest tier for income above $160,001 (single) and $320,001 (joint), will pay a combined $369.40 monthly surcharge for Part B and D (or $738.80 per couple per month). In 2019, a 5th tier will be added for income in excess of $500,000 single, $750,000 joint. While the new rates have not yet been announced, the surcharge for this new highest rate is expected to be around 6% higher than the highest level for 2018. You can visit www.medicare.gov to get more information on the IRMAA rates for 2018.
The IRMAA surcharge is determined annually based on your MAGI for the second prior year. That is, your 2016 MAGI was used to determine your 2018 IRMAA, and the 2017 return that you filed this year will determine your IRMAA rate for 2019. While Medicare does allow you to appeal your IRMAA rates based on certain “life changing events,” such as death, divorce, retirement, etc., there is no exception for one-time income events, such as large capital gains, a large Roth IRA conversion, or even winning the lottery. If income returns to normal levels the next year, the next year’s IRMAA surcharge will automatically be adjusted downward. Lastly, IRMAA surcharges apply on a “cliff” basis. That is, if your income is just at the threshold for a tier, the full surcharge for that tier applies to you (and your spouse if you are married) for the entire year.
With this background, here are some strategies to avoid or minimize the impact of these rules.
Pay Attention to Income Levels
It is important to know whether your estimated MAGI will be close to the cliff of one of the tiers. If you have some room within a tier, you might be able to accelerate some income into that year if you know you will likely be above that tier the next year. Likewise, if you are close to a tier income limit, consider ways of deferring income or taking losses in that year to avoid going over the cliff. As long as you have enough liquidity to cover living expenses, investing for long-term appreciation and tax-deferred income, rather than current income, can help.
Consider a Roth IRA Conversion to Reduce Future RMDs
Someone who reaches age 70 ½ with a large IRA might experience “sticker shock” when they realize that the Required Minimum Distributions (RMDs) from the IRA increases MAGI above the next tier, costing the individual thousands of dollars in increased Medicare premiums. A Roth IRA conversion strategy, properly planned out, can help minimize this impact. Roth IRAs are not subject to RMDs and any distributions from the Roth are tax-free, so converting an IRA to Roth has the double effect of reducing the future RMDs from the regular IRA and also creating a source of tax-free funds, the use of which will not change MAGI. However, this strategy is a double-edged sword, since converting a regular IRA to Roth is a taxable event and increases MAGI in the year of the conversion. Thus, a large conversion in single year might cause a one-year increase in Medicare premiums.
While this might still make sense depending on the future premiums saved, a better strategy would be to do a series of small Roth conversions, either before Medicare eligibility, or while there is some room within the various IRMAA tiers. Of course, a Roth IRA conversion strategy must always be considered in light of the entire tax picture. There may be very good income tax reasons to convert an IRA to a Roth even without Medicare impact, especially in light of the new expanded tax brackets, if the conversion will reduce the tax rate on future RMDs. On the other hand, converting an IRA to save Medicare premiums will not make sense if the increased taxes on the conversion more than offset the projected future Medicare premium savings.
Use the Qualified Charitable Distribution Opportunities
We have written about this strategy many times. If you are older than 70 ½, you can distribute up to $100,000 annually from your IRA to one or more charities, but not to a donor advised fund or private foundation. This distribution can be used to satisfy your RMD. Properly done, this distribution does not appear as income on your federal tax return, and accordingly does not increase MAGI. So, if you use this strategy, all or part of RMD is excluded from income, and would have no impact on the IRMAA calculations.
Fund an HSA
If you are younger and participate in a high deductible medical plan, you should always fund your HSA to the maximum degree possible, even if it means not funding an IRA or 401k plan, but take advantage of a company match first. Contributions to an HSA are tax-deductible, like a contribution to a retirement plan, grow tax-deferred, also like a retirement plan, but are not taxed when used for qualified medical expenses, unlike a distribution from a retirement plan, which is taxed. Because a qualified distribution from an HSA is tax-free, it has no impact on MAGI and therefore Medicare rates.
Use Tax-Free Source of Liquidity
If you find yourself close to the income level of one of the IRMAA rates, but need liquidity for living expenses, consider tapping into a tax-free source. For example, consider borrowing against the cash value in a life insurance policy before taking a taxable distribution from a retirement plan. Home equity also can be accessed in a tax-free manner, either through a line of credit or a reverse mortgage.
Of course, you should always consult with your own tax advisor before considering any of the strategies. We are here at Ancora to help with the conversation. Please contact your relationship manager if you want any more information.