Avoiding the Medicare Surcharge: What You Need to Know About IRMAA
Finally being eligible for Medicare solves one of the largest problems you will face in retirement: healthcare. One benefit of Medicare is being able to select various Parts and plans that pertain to your needs. After you have made the adjustment, Medicare can be convenient and affordable for those turning 65. However, Medicare costs are directly related to your income. If you make over a certain amount of income, extra surcharges on your Medicare premiums start to kick in. Ouch!
To make things worse, the surcharge increases are not a flat rate. The surcharge continues to rise as you have higher amounts of income. These increases can rise to several hundred dollars in extra payments per month.
The key to avoiding or minimizing the surcharge is to control your income levels. Many people may have a relatively easy time controlling their income levels in the early stages of retirement. However, if most of your retirement income will be coming from Traditional IRAs or 401(k)s, you could be in for a mean surprise.
Once you hit age 72 (at the time of this writing), you will be forced to start taking minimum withdrawals from these tax-deferred accounts. The IRS wants their tax cut from these funds sooner rather than later! Each year, the minimum amount will increase. These extra withdrawals could bump you into higher tax brackets, and higher Medicare brackets as well, resulting in a hefty bill.
What is IRMAA?
Medical insurance (Part B) and prescription drug insurance (Part D) are paid by a combination of the federal government (75%) and a monthly premium paid by you, the Medicare enrollee (25%.) The IRMAA, which stands for Income-Related Monthly Adjustment Amount, is a surcharge applied to the Part B and Part D premium.
This amount is calculated by the Social Security Administration, using recent information on your tax return provided by the IRS. You will be notified if your annual income will trigger an extra surcharge. The Social Security Administration looks two years back at your income, to allow lag time for the tax returns to be processed. For example, your 2022 Medicare IRMAA payments are calculated based on your 2020 income.
Right away, you can see a few problem areas, depending on your situation. Assuming you work right up until age 65 when Medicare begins, your salary could trigger the surcharge before your income lowers in retirement. All is not lost though, there could be a few areas to save you. You can request a "new initial determination" to get the SSA to recalculate your surcharge. There are five ways to qualify for this:
- An amended tax return since your original tax filing
- Correction of IRS information
- Use of two-year-old tax return when SSA used IRS information from three years prior
- Change in living arrangement from when you last filed taxes (e.g., filing status is now “married filing separately,” but you previously filed jointly
- Qualified life-changing event
The last item, "qualified life-changing event," would be the one that covers a work stoppage.
Managing Retirement Income While Watching IRMAA
The IRMAA is calculated on what’s called your Modified Adjusted Gross Income, which is your AGI plus certain interest income. So, the key is to maintain as low a taxable income as possible. Since, for many people, income in retirement comes from withdrawals to investment accounts, that's the first place to think about minimizing the IRMAA.
See my other article “How To Reduce Your Lifetime Income“ for strategies to help with tax planning around your retirement income.
Selling investments you have owned for more than one year and that don’t have lots of capital gains embedded in them can help control your taxes in retirement.
At age 72, your RMDs (required minimum distributions) will begin, and they can be hefty. The first year of RMDs on a $1 million portfolio can be as much as $40,000. You can avoid RMDs altogether by converting some or all of your traditional tax-deferred retirement savings accounts to Roth accounts before Medicare kicks in. You'll need to plan carefully, but using the funds as a sole source of income can also help you delay taking social security benefits, which will increase the amount you receive.
The Bottom Line
Medicare can be a great way to access healthcare in retirement, but planning around your retirement income is a must. Looking ahead and including social security benefits in your planning can help you maintain the income you need and minimize the taxes you pay. We don’t ever want the “tax tail to wag the dog” in our planning, but if there is a way to reduce your tax and surcharge payments within reason, you should know about it.
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