Navigating the early days of retirement can be tough. Between adjusting to new routines and getting used to a different budget, many new retirees experience struggles in this next phase of life. Inflation risk and higher prices are other factors that new retirees must contend with now, too. Social Security cost-of-living adjustments will be higher in 2023, but that may not be enough to offset Medicare premium adjustments.
Income from two years ago is the key determining factor for how much monthly Medicare premiums will be in the current tax year. Knowing when – and how – to request lower premiums is an often-overlooked part of retirement tax and income planning. Current retirees and workers who are planning to retire in the next two years can plan ahead, potentially pay lower monthly surcharges, and better manage retirement income.
Medicare IRMAA Defined
Navigating Medicare in retirement is complex.
Medicare Part A – which covers hospital and inpatient expenses – is free, but Parts B and D – medical care and prescription drug coverage, respectively – are not. Many high-income retirees need to pay surcharges for their Medicare premiums, which can be several hundred extra dollars per month depending on income. Taxpayers below the thresholds pay 25 percent of the standard premium, whereas taxpayers whose income is above certain thresholds will pay more than the standard premium.
Monthly premiums are based on modified adjusted gross income (MAGI) two years before the current year. That means that monthly premiums in 2023 are figured using 2021 income. Since 2020, the thresholds are adjusted for inflation annually.
2023 surcharge amounts are figured using a lower threshold that reflects an inflationary environment; though the thresholds are only about five percent lower, it’s still helpful to plan around.
These surcharges based on income are called income-related monthly adjustment amounts (IRMAA). They apply to Medicare Part B coverage; insurance companies determine Part D premiums, and monthly surcharges ranging from about $12 to $76 may be added based on the individual’s MAGI.
What can often happen with Medicare IRMAA is that retirees don’t even know how much the surcharges actually are or they simply accept that the fees cannot change. In some situations, retirees can appeal the surcharges and request an adjustment to their monthly premiums. But it’s not automatic.
It’s estimated that around 4.4 million Medicare enrollees qualify for lower premiums, or about seven percent of 63.3 million Medicare beneficiaries.
How to Appeal IRMAA Adjustments
Especially given the pandemic, some new retirees may have the option to request a lower IRMAA. Some possible examples might include when:
- An individual took early retirement in 2020 or 2021
- Income levels dropped suddenly
- There was another form of a life-changing event, which is what the Social Security Administration (SSA) defines as marriage, divorce, spouse death, being laid off from work or forced to work reduced hours, in addition to substantial loss of income mentioned above.
If a retiree qualifies for reduced IRMAA, they would need to complete and file Form SSA-44 with all required documentation.
Form SSA-44 requires proof of a reduction in income, like a tax return, a letter from a former employer, a recent pay stub, or a death or marriage certificate. If the SSA agrees with the request, they will credit any extra IRMAAs retroactively. This process can take time.
Options to Avoid Higher Medicare Premiums
Knowing how MAGI is calculated can help new and soon-to-be retirees better manage future Medicare premiums.
MAGI starts with adjusted gross income from the tax return, then adds back:
- Tax-exempt interest income
- Interest from certain U.S. savings bonds
- Ex-pat earned income that wasn’t previously included
- Other income from U.S. territories that wasn’t previously included
For workers who are planning for retirement in the next two years, paying attention to current IRMAA income thresholds is key. Keeping MAGI under a certain amount can be done in several ways; for example, making a qualified charitable contribution or QCD from retirement accounts, taking capital losses, accelerating certain business expenses, or making pre-tax retirement plan contributions are all ways to lower MAGI.
Converting some or all existing retirement accounts into a Roth IRA may be another planning strategy to lower future MAGI and taxable income. Because Roth retirement distributions are tax-free, that retirement income wouldn’t be included in the annual MAGI calculation. The catch is that any Roth conversion amount would be taxed up front and increase the MAGI in the year of the conversion. Spreading a large Roth IRA conversion over several tax years can oftentimes lower a retiree’s MAGI exposure and Medicare premiums, especially in years when their income might be lower than normal. Another major benefit of Roth IRAs is that they are not subject to the required minimum distribution (RMD) rules starting at age 72. Read more about converting Roth IRAs in our recent tax blog article.
Managing which investments are subject to capital gains could be another way to monitor MAGI and taxable income. Some mutual funds will pay out significant capital gain distributions and dividends at the end of the year, which count as taxable income and catch many investors by surprise; opting instead for a mix of exchange-traded funds could prove helpful as these funds are not required to annually pay out capital gain distributions.
And individuals who are at least 70 ½ or 72 can use an IRA distribution as a qualified charitable distribution to meet their required minimum distribution while also minimizing MAGI and taxable income.
When planning for retirement income, more isn’t always better. There may be retirement plan distributions, Social Security payments, pension or annuity payouts, capital gains, and other income sources. Individuals and couples will need to balance their income and expense needs with the potential for higher Medicare premiums. Retirees should always be conscious of the IRMAA rules and the MAGI two-year look back.
For questions about Medicare premiums, retirement tax planning, and how to manage retirement income, contact Charles Dean Smith, Jr., CPA.