The federal government is expected to run a deficit of $3.0 trillion this year, adding to a national debt that already totals more than $28 trillion. Politicians will be looking for ways to increase revenue (i.e., raise taxes) and reduce spending. Two of the most expensive federal spending programs are Social Security and Medicare. It has long been suggested that one way to curb the growth of these programs is through means-testing: reducing benefits for those who financially need the benefits the least, without affecting those who need the benefits the most.
You may be surprised to learn that Social Security and Medicare are already means-tested to some extent. Social Security is a tax-free benefit for those with low income. Once income exceeds $25,000 for single taxpayers, some Social Security benefits become taxable. For those with higher incomes, up to 85% of benefits can become taxable.
Means-testing Medicare
Medicare premiums are means-tested through Medicare’s income-related monthly adjustment amount (IRMAA) program, which was established in 2003. Individuals who reported Modified Adjusted Gross Income (MAGI) under $88,000 and married couples filing jointly who reported MAGIs under $176,000 on their 2019 returns are paying the current Medicare Part B basic premium of $148.50 per month. Those with higher MAGIs pay an IRMAA surcharge on Part B and Part D. This is assessed across five income levels, and someone in the highest level pays the premium plus a surcharge of more than three times the basic Medicare premium.
Beginning in 2020, IRMAA brackets became indexed to inflation. This means that a retiree will need to have a higher MAGI than previous years to be subject to the surcharges. The MAGIs for 2021 are $88,000 for single filers and $176,000 for joint filers.
Some retirees expecting a January cost-of-living increase in their Social Security benefit are shocked to find their net benefit is lower because they reached a level that triggered IRMAA. IRMAA levels can be triggered when required minimum distributions (RMDs) from IRAs begin at age 72—or when an asset is sold for a significant capital gain. A skilled retirement specialist can help minimize or avoid IRMAA surcharges by planning and taking advantage of opportunities as they present themselves.
Strategies To Minimize Medicare Premiums
Save tax-efficiently for retirement.
At Rodgers & Associates, we don’t limit diversification to investing; we also diversify to minimize taxes. Tax diversification involves allocating investments across accounts and assets that are taxed differently. We call our strategy the New Three-Legged Stool™ of tax-efficient retirement planning.
Leg One | Taxable Accounts: This category includes all non-retirement investment accounts. Earnings in these accounts are generally taxable each year.
Leg Two | Tax-Deferred Accounts: Account types include IRAs, 401(k)s, 403(b)s, and most retirement accounts. Earnings in these accounts are generally deferred until later.
Leg Three | Tax-Free Accounts: This is where Roth IRAs and Roth 401(k)s come in. Earnings in these accounts are generally tax-free when withdrawn.
Tax-efficient withdrawals at retirement.
Continuing to defer taxes on distributions from qualified accounts in Leg Two after retirement could result in balances growing too large. The required minimum distribution (RMDs) could force the retiree into an IRMAA surcharge bracket. Retiree income should be pulled from all three legs tax efficiently with a long-term outlook that keeps RMDs under control in later years. There is no rule of thumb for long-term tax planning. Every retiree’s situation is unique. IRMAA minimization is one factor influencing the withdrawal order, but there are others to be considered.
Consider Roth conversions to balance the New Three-Legged Stool™
It’s not uncommon for someone to retire with a lopsided stool. When started early, a sound conversion strategy can help avoid thousands of dollars in higher Medicare premiums. A Roth conversion occurs when all or part of an existing traditional IRA is converted to a Roth IRA. One strategy would be to start doing Roth conversions in small amounts early to shrink an IRA to the point that the required distributions do not impact Medicare premiums. Moving from an IRA to a Roth IRA creates a taxable event. This may result in paying more taxes in the current year as well as IRMAA surcharges. Long-term planning is needed to assess whether the future benefits will offset the tax bill created by the conversion.
Use required minimum distributions for charitable contributions.
A qualified charitable distribution (QCD) allows individuals over age 70½ to directly transfer up to $100,000 from an IRA account to one or more charities. This transfer counts towards the required minimum distribution, but it doesn’t add to the taxpayer’s MAGI. Making a QCD could lower MAGI enough to keep a senior out of the IRMAA surcharge range.
Tax Loss Harvesting.
An unusual amount of realized capital gains is often the reason seniors reach the IRMAA levels. The sale of real estate that has been held for many years and depreciated or exercising of stock options can create one-time taxable income that triggers the premium increase. Look for unrealized losses in the portfolio that can be taken to offset gains. An unrealized loss occurs when a security has decreased in value from the purchase price. The unrealized loss does not have a tax benefit and is not tax-deductible. The security must be sold to capture the loss for tax purposes. The proceeds of the sale are often used to purchase a similar (but not substantially identical) security to maintain exposure to that market category.
There is a process available when an IRMAA surcharge is applied incorrectly. The Social Security Administration has an appeal process and lists several qualifying reasons for requesting a reconsideration of the premium increase. The appeal is filed on Form SSA-44. However, there is no guarantee an appeal will be successful, so the best course of action is to avoid the IRMAA surcharge in the first place when possible.
Rick’s Insights
- Medicare’s IRMAA surcharges for higher-income retirees are a form of means-testing.
- With appropriate income withdrawal strategies, a retiree can lessen their exposure to IRMAA surcharges.
- Roth IRAs, qualified charitable distributions, and tax-loss harvesting can be valuable tools.
Originally posted February 2012
