Many Americans look forward to the day when they can apply for Medicare as their primary health insurance. While Medicare is typically affordable for most participants, families with high incomes are often met by an unwelcome surprise when they realize that Medicare premiums can be adjusted higher for them due to their high incomes.
To add insult to injury, many of the taxpayers who see their Medicare premiums adjusted higher are the same taxpayers who paid the most Medicare tax during their working years as well! A double whammy to unsuspecting high-income earners.
While Medicare premium adjustments are a fact of life, taxpayers who are proactive can consider tax planning strategies to manage their income and reduce the amount of Medicare premium adjustments they pay during retirement.
How Medicare Premiums Work:
Once a retiree reaches age 65, they have the option to enroll in Medicare to cover their health insurance needs. Medicare comes in different parts and each part is paid for differently. The major Medicare parts are Part A (hospital insurance), Part B (medical insurance), and Part D (prescription drug coverage).
- Medicare Part A (Hospital Insurance): Medicare Part A is provided to most retirees at no cost to them. The cost of Medicare Part A is primarily covered by payroll taxes paid in by employees, employers, and self-employed individuals.
- Medicare Part B (Medical Insurance): Most retirees are required to pay a premium for Medicare Part B. For those receiving Social Security benefits, the Medicare Part B premium is typically deducted directly from their benefits.
- Medicare Part D (Drug Coverage): Medicare Part D premiums can be paid directly to the insurance provider or through automatic deduction from the retiree’s Social Security check.
The Cost of Medicare Premiums:
Both Medicare Part B and D include a premium that is billed to the retiree. The cost of Medicare Part B and D is not fixed; rather it is based on income thresholds. Individuals with higher incomes pay a larger premium.
This increased premium for high-income individuals is called an Income-Related Monthly Adjustment Amount (IRMAA) and is intended to increase the cost for individuals who are able to afford higher premiums.
The following two tables list the amount that each individual on Medicare will pay on a monthly basis for Medicare Part B and D coverage.
Key Takeaway:
Medicare premiums are not fixed. They can increase based on income.
The IRMAAs are applicable to EACH INDIVIDUAL; so, a married couple with both spouses on Medicare could see their combined premiums increase substantially if their income exceeds the highest threshold.
To demonstrate, single individuals with income over $500,000 and married individuals with income over $750,000 would pay $560.60 for Medicare Part B which represents a $395.70 increase per month over the base premium, and their Part D premium adjustment would increase from $0 to $76.40.
For a married couple that pays the increased premiums for an entire year, their total cost of Medicare is $15,288 per year. That’s $11,330.40 higher than the cost of the same coverage for a married couple whose income is below the first threshold.
The numbers shown in the table above ignore the cost of any supplemental plans which only increase the costs of health insurance. With numbers like these, it is easy to see why many high-income families are shocked when they apply for Medicare and realize their monthly insurance premiums are actually higher than what they are accustomed to paying prior to retirement.
How Is Income Determined?
IRMAAs are based on modified adjusted gross income (MAGI) which includes adjusted gross income (AGI) per the tax return as well as any tax-exempt interest. The MAGI used in the calculation for the current year’s Medicare premium is based on the taxpayer’s tax return from two years prior. For example, 2023 Medicare premiums are based on MAGI from the taxpayer’s 2021 tax return. Accordingly, IRMAA planning needs to begin two years prior to applying for Medicare.
Additionally, IRMAA premium increases are not phased in gradually. Rather they are cliff thresholds meaning that even $1 of income over a threshold amount will cause a full adjustment to the next premium level.
To clarify, if a married couple has $194,001 of MAGI, their Part B premiums will increase from $164.90 to $230.80 and their Part D premiums will increase by $12.20. For a full year, that represents an additional $1,874.40 in premiums for the couple simply because their income exceeded the $194,000 threshold by $1. Any planning that would have reduced the couple’s income by $1 would have saved them $1,874.40 in additional premiums.
Key Takeaway:
IRMAA thresholds are cliff thresholds meaning $1 of income over a threshold will result in a full premium adjustment.
For an average couple who may not have $194,000 in annual income, is it necessary to consider IRMAAs? Often the answer is yes. While having consistent income of $194,000 may not be the norm for everyone, it remains important to consider in light of one-time events or specific planning opportunities such as:
- Selling a business or real estate
- A large bonus payout
- An inherited IRA distribution
- Roth conversions
- Harvesting capital gains, etc.
Each of these events represent taxable income which will impact a family’s income for IRMAAs purposes. So even families that don’t typically fall into the category of “high-income” need to consider whether one-time events or specific planning strategies may result in higher Medicare premiums in the future.
Accordingly, advisors or individuals making planning recommendations need to understand the related impact to Medicare premiums. The recommendations may still be worthwhile, but the increased cost of Medicare premium adjustments needs to be considered.
Can Individuals Appeal Their IRMAA Adjustments?
In certain cases, Medicare allows individuals to file an appeal to their IRMAA surcharges. Appeals are only allowed based on specific life-changing events. These life changing events include the following:
- Death of spouse
- Marriage
- Divorce or annulment
- Work reduction
- Work stoppage
- Loss of income from income producing property
- Loss or reduction of certain kinds of pension income
While filing an appeal when one of these life changing events applies can provide an option to mitigate IRMAA increases, in most cases the IRMAA adjustment will be due to non-life changing events and the individual will have to pay the higher Medicare premium for the entire year. When possible, it is better to plan ahead than to hope for a successful appeal.
How To Minimize the Impact of IRMAA Thresholds:
Since IRMAA adjustments are based on a taxpayer’s modified adjusted gross income, tax planning is key. For retired individuals, the following represent example strategies that can serve as a tool for controlling overall income:
- Controlling capital gains in a given year by choosing to sell positions at the end of one year versus the beginning of another.
- Tax loss harvesting positions that are at a loss. The losses can be used to offset current year capital gains as well as up to $3,000 of ordinary income. Excess losses can be carried forward to future years to offset capital gains.
- Keeping IRMAA thresholds in mind when calculating Roth conversions to ensure the total cost of the conversion is understood.
- Considering deductible 401k and IRA contributions to manage income if one spouse is still working.
While each family’s situation may result in different strategies being employed, the important point is that Medicare’s IRMAA surcharges can be reduced by those who understand how to plan for them.
Conclusion:
Medicare Part B and D premiums can be a significant cost for retired individuals. For high-income taxpayers who have to pay the IRMAA surcharges, the cost of Medicare is often an unwelcome surprise.
Given IRMAA adjustments can increase significantly due to even a single dollar of extra income, income and tax planning become an important part of any strategy to manage the total cost of Medicare premiums.
If you are interested in working with a Family CFO to learn more about IRMAAs and to ensure you have a plan to manage the cost of your Medicare premiums, we would love to connect to see if what we do is right for you.
