Part B and D Charges
The Medicare health care system is largely government funded, but individuals pay premiums to participate in two portions of it.
Medicare charges premiums to participants in Medicare Part B, covering doctor visits, and Part D, the prescription drug benefit. In 2021 the basic premium for Part B is $148.50 per month. The premium for Part D varies by plan.
The standard premiums for these are increased by surcharges imposed on upper-income individuals, those with Modified Adjusted Gross Income (MAGI) exceeding $88,000 on an individual return or $176,000 on a joint return. In 2021 the largest premium surcharges apply to persons with MAGI of $500,000 or over on a single return or $750,000 or over filing jointly.
The extra amount that higher-income individuals must pay is called an Income Related Monthly Adjustment Amount (IRMAA). The first five IRMAA tiers for Medicare premium surcharges are adjusted for inflation each year. This could result in reduced Medicare premiums for some. The IRMAA tier for individuals earning $500,000 or more (or married couples with MAGI of $750,000 or more) will not be adjusted until 2028.
For Medicare Part B the largest surcharge is $356.40 per month or $4,276.80 per year. This increases the monthly premium to $504.90. For Part D the largest surcharge is $77.10 per month or $925.20 per year. Combined, the two surcharges can total $433.50 per month or $5,202 per year.
Combination Chart- Parts B and D
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.
If Bob has MAGI of as much as $88,000 on his single return, he’ll owe no surcharge. But if his income reaches $88,001 then a monthly surcharge of $59.40 for Part B plus $12.30 for Part D, or $71.70 total, will apply for all 12 months of the year. Bob’s $1 of additional income increases premium cost by $860.40 for the year.
Medicare Planning Points
Medicare premium surcharges are imposed on individuals with MAGI over $88,000 on a single tax return or $176,000 on a joint return.
For IRMAA purposes, MAGI is defined as Adjusted Gross Income (AGI) plus tax-exempt interest and untaxed foreign income. Medicare uses the MAGI reported on the federal tax return from two years ago. For example, to determine whether someone will pay higher premiums for 2021, Medicare uses 2019 MAGI.
Similarly, the tax return filed for 2021 will be used to calculate IRMAA surcharges for the year 2023.
Address required minimum distribution (RMD) requirements well in advance of the required beginning date, explaining how RMDs are included in income for Medicare Part B and Part D costs two years down the road. RMDs are not required from Roth IRAs during the Roth IRA owner’s lifetime.
Don’t forget that this includes older beneficiaries who are also subject to RMDs on IRAs they have inherited.
Income Reduction Strategies
The key to reducing Medicare surcharges is to reduce MAGI. Items like itemized deductions won’t do that. They only reduce taxable income.
Check the tax return during the year to see if reported MAGI is near one of the threshold amounts. If income is close enough, plan to realize income and deductions to keep MAGI below the nearest threshold.
A Roth IRA conversion can be useful in minimizing future IRMAA surcharges as distributions from the Roth IRA can be tax free, reducing MAGI.
To avoid a current income spike from a Roth conversion, consider making a series of partial conversions over a number of years to avoid pushing income into higher tax brackets. This is a strategy that requires long-term advance planning.
For those in early retirement, consider the benefit of converting before the conversion income would impact Medicare costs.
Converting later may still be an effective strategy. A Roth conversion would negatively affect MAGI for Medicare purposes but only for one year. It may make sense to take the hit in one year in exchange for no RMD concerns in future years.
HSAs (Health Savings Accounts)
Younger people may want to consider funding a Health Savings Account (HSA) rather than an IRA if they have a choice. They can make deductible HSA contributions in their working years, use other funds to pay medical expenses, and then they can access their HSA tax- and penalty-free to pay for qualified medical expenses in retirement. These distributions would not be included in MAGI for Medicare purposes the way RMDs and other traditional IRA distributions are.
QCDs (Qualified Charitable Distributions)
As a result of the tax law’s increased standard deduction amounts, many are no longer deducting charitable contributions. QCDs can help restore charitable tax benefits by having those QCDs excluded from income. The exclusion from income will help to avoid Medicare premium increases.
With a QCD, an IRA owner (or beneficiary) who is age 70½ or over can transfer up to $100,000 annually from their IRA to a charity tax-free.
A QCD can count towards the RMD and is not included in MAGI for determining Medicare costs. Keeping the RMD amount out of MAGI can result in big savings. This is not the case if an IRA owner takes their RMD and then donates to charity and claims a charitable deduction (if they can at all). With that approach, the RMD would still be included in MAGI.
For those taking RMDs, consider how a QCD could help to save on Medicare costs.
Other strategies that can be used to manage MAGI to minimize Medicare surcharges include:
- Timing investment gains and other income by accelerating them onto a tax return for a year before IRMAA calculations occur
or deferring them to a year when income is expected to be lower and there may be offsetting losses.
- Obtaining spending funds from tax-free sources. For instance, one may borrow against a life insurance policy rather than
take a taxable distribution from a retirement plan or use tax-free proceeds from the sale of a principal residence (as much as
$250,000, or $500,000 on a joint return).
- Using a home equity conversion mortgage (HECM - reverse mortgage line of credit) to provide a source of tax-free funds with no corresponding mortgage payment expense, to keep income below the Medicare surcharge threshold amounts.
When Income Falls
If there has been a major life-changing event that results in a large reduction in MAGI, an individual may request to use their MAGI for a more recent year. If an individual disagrees with the decision about their Medicare costs, they have the right to appeal.
Do this by submitting Form SSA-44, “Medicare Income-Related Monthly Adjustment Amount - Life-Changing Event,” to the Social Security Administration.
The end of employment is a qualifying “life-changing event” that should be considered for every client who retires at age 65 or later. If an IRMAA surcharge will result from high salary income reported on a return filed two years earlier, but that salary no longer exists, relief from the surcharge may be readily available.
Copyright © 2021 Ed Slott and Company, LLC. Reprinted with permission. Ed Slott and Company, LLC takes no responsibility for the current accuracy of this information.
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