Medicare is the largest healthcare program for seniors. In 2003, concerns about its solvency enacted IRMAA as part of the Medicare Modernization Act to make it more of a cost-sharing program. The government pays a majority share (around 75 percent) of the Part B and Part D benefits, while beneficiaries contribute 25 percent.
High-net-worth individuals can end up paying thousands of dollars more in medical care each year if they aren’t careful. The good news is there are ways to minimize IRMAA by reducing your taxable income.
- Medicare IRMAA is an annual adjustment to your Medicare Part B and Part D premiums, which starts at $164.90 and could be as high as $560.50 in 2023.
- Your IRMAA is based on your MAGI two years prior (i.e., 2023 premiums will be based on your 2021 MAGI from your 1040 tax return).
- Managing your tax liability and overall MAGI is key to minimizing IRMAA surcharges.
What is Medicare IRMAA?
Income-related monthly adjustment amount (IRMAA) is a surcharge on Medicare Part B and D premiums if your income is above certain thresholds. Your modified adjusted gross income (MAGI), as reported on your IRS tax return from two years ago, determines your premium—requiring some strategic planning on your end.
You’ll pay a higher premium in 2023 if your MAGI in 2021 is more than
- $97,000, if you file individually
- $194,000, if you file jointly
There are five more IRMAA brackets you could fall into, and the premium increases with each one.
Part B Premiums
Part D Premiums
IRMAA adjusts annually, so keeping a close eye on your MAGI is key to minimizing Medicare premiums.
Managing Your MAGI
MAGI is the “magic” number that determines what you’ll pay in taxes and premiums and if you qualify for further benefits or surcharges. You don’t want this number to be a surprise when you file your taxes! There are a few ways to make sure you don’t put extra stress on your retirement income, and each requires tax efficiency.
Consider Your Income Tax Liability
Step one is building a plan for your income in retirement or a withdrawal strategy. You can pinpoint where, when, and how much you withdraw, but you need to have various retirement funds to pull from.
Regarding tax liability, you’ll want a range of pre-tax, after-tax, and taxable funds at your disposal.
- Pre-tax accounts (401(k) or IRA): Contributions and earnings are tax-deferred; you only pay tax when you withdraw.
- Tax-free accounts (Roth): Contributions are taxed before you contribute, so any future withdrawals and earnings are tax-free.
- Taxable accounts: Interest, dividends, and capital gains are taxed each year.
- Benefits and annuities like Social Security or pensions are taxed as ordinary income in the distribution year.
Finding the right strategy for you depends on one key question: How long will my money last?
Here are a few strategies to consider:
These examples assume that “Joe” is 62 and single. He has $200,000 in taxable accounts, $250,000 in pre-tax accounts, and $50,000 in Roth accounts.
This traditional approach allows your pre-tax accounts to grow longer and faster but creates a tax bump during the middle years of your retirement. Not shown here—but implied—is a higher Medicare premium.
While paying taxes isn’t “bad,” it’s important to ensure you don’t overpay and keep as much money as is legally allowable.
If you have a sizeable nest egg, you may need to pay more in taxes. But if you planned for the tax bump and saved money accordingly, then there are no surprises, and you’re still on track to making your money last the duration of your retirement.
Here’s another example.
This strategy takes a little from every type of account each year instead of draining one before moving on to the next. By spreading your funds, you can reduce taxes, extend your portfolio, and reduce your Medicare premiums.
But everyone’s needs are different, so we can help you create a withdrawal strategy that works for you.
Keep Your Ongoing Investments Tax-Efficient
Investments become more tax-efficient as they stay in the market and qualify for long-term capital gains tax rates. Here are a few options to consider.
Asset Location Strategy
This strategy encourages investors with numerous equity and fixed-income investments to determine which securities should be in tax-deferred accounts (401(k) or IRA) and taxable accounts.
Generally, you should hold securities with lower capital gains and dividends in taxable accounts to take advantage of their low tax rate. Actively managed mutual funds or real estate investment trusts (REITs) are more appropriate in tax-deferred accounts.
Often called triple-free because the interest income isn’t taxable at the federal level and usually not at the state and local level either.
Treasury and Series I Bonds
These savings bonds are exempt from state and local income taxes. Treasury bonds also allow the option of withholding up to 50% of your interest earnings as a credit against your income tax bill. You can defer tax on Series I bonds (even on earnings) until redeemed.
Exchange Traded Funds (ETFs)
ETFs operate similarly to mutual funds. They track a specific index, sector, or commodity and are traded on a stock exchange at any time, like a regular stock. They generally have fewer taxable events, such as the capital gains distributions, making them more tax-efficient than mutual funds.
Managing Your Required Minimum Distributions (RMDs)
An RMD is an amount you must withdraw from certain retirement accounts each year to avoid tax penalties. You must take RMDs beginning at age 72.
Once you reach the minimum RMD age, there’s no way to reduce the amount of your RMD, keeping your taxable income fairly constant. But there’s a workaround if you don’t need all your RMDs for living expenses: qualified charitable distributions (QCDs).
With a QCD, you can instruct your IRA account trustee to send your distribution directly to the charity of your choice. This way, you’ll still technically receive your RMD and lower your taxable income.
Another bit of good news for RMDs actually comes from the IRS. They changed their actuarial table (what they use to calculate your RMD amount), extending the distribution periods. Changes took effect in January 2022 and could mean a lower RMD, MAGI, and IRMAA than expected.
Image credit: Internal Revenue Service
Timing Roth Conversions
Roth conversions are excellent when you want to build up tax-free income, but they can come with a tax bill. As it concerns your MAGI and potential Medicare IRMAA, you could be in a higher bracket with higher premiums if you convert too much in one year.
Completing Roth conversions early on in retirement and staging them in smaller amounts tend to be more effective.
Medicare IRMAA, while beneficial for the overall Medicare program, can be a shock to retirees who haven’t planned for them. Work with your financial or tax advisor to ensure you’re doing what you can to manage premiums and still meet your needs. IRMAA adjusts annually, but if your circumstances drastically change during the year, you can appeal it.
To help you understand the rules, deadlines, and exceptions involved with your retirement plan, set up a free consultation with Metanoia.