Many retirees are conscious of the fact that they become eligible for Medicare at age 65.  The ability to switch healthcare coverage from an employer-provided plan to government-sponsored Medicare starting at that age can play a large role in determining target retirement dates due to health care’s potentially high share of planned retirement spending.  What fewer people may be aware of is that the premium rates being charged for Medicare are affected by a taxpayer’s income.  Due to the Income-Related Monthly Adjustment Amount (IRMAA), not everyone pays the same rates for their Medicare coverage.  This article will discuss how the IRMAA is calculated as well as some ways that tax planning can help avoid incurring these additional premium charges.

The standard monthly premium for Medicare Part B is $148.50.  However, depending on your tax return from two years before, this amount can be adjusted higher by the government.  The income measure used to determine the adjustment is modified adjusted gross income (MAGI), which is defined as your adjusted gross income (AGI) plus untaxed foreign income and tax-exempt interest.  The following table highlights the break points for moving into a higher Medicare bracket based on 2019 MAGI:

These premium adjustments can be quite costly, as a married couple earning $300,000 will pay more than two-and-a-half times the lowest premium, resulting in extra expense of roughly $5,700 per year on top of the $3,500 in base premiums. 

As shown above, the brackets are the same for determining premium adjustments for both Part B and Part D (prescription drug plans).  The adjustment is two years backward looking—with 2021 premium determined by 2019 income—because most taxpayers will not have filed their 2020 income tax returns when the 2021 premiums are determined.  An important caveat to note here is that these brackets are cliff points, meaning that a retiree would pay the same increased premium whether over the income limit by $1 or $100,000.  This contrasts with the federal income tax system, where only dollars earned in each bracket are taxed at that bracket’s marginal rate.  For example, a married couple earning $176,000 will pay $3,564 in Part B premiums while a couple earning $177,000 pays $4,990—essentially, a Medicare “tax” rate of over 100% on the additional $1,000 of income.  This can make avoiding these break points where possible a valuable tax planning strategy.

Because of the backward-looking nature of the adjustment, the Social Security Administration (SSA) does allow taxpayers to contest their annual determination if they have experienced a major life change.  There are several circumstances that are considered life-changing events, with some of the most common being death of a spouse, marriage, divorce, and retirement.  If any of these apply, Form SSA-44 can be used to report a life-changing event and request a new determination of the IRMAA, if any.  By reporting new income data and documenting the appropriate event, the SSA may revise the initial IRMAA determination to a lower level.  Even if someone does not qualify for a new determination based on a life-changing event, there is an appeals process to continue making the argument for a lower determination.

The IRMAA premium penalty could be avoided or limited with careful tax planning.  Although it can be a bit of a moving target since the inflation-adjusted brackets are not announced until after the relevant income to determine that year’s IRMAA has been earned, it is possible to plan using the current brackets or building in some basic inflation assumptions.

Traditionally, the large income items for retirees are pensions, Social Security benefits, taxable retirement plan (IRA, 401(k)) distributions, and investment income.  Since the first two are usually out of the retiree’s control, the retirement plan distributions and investment income come into focus for tax planning purposes.  It is important to remain cognizant of these IRMAA surcharge brackets when making withdrawals from retirement plans in addition to the required minimum distributions mandated by the IRS.  Drawing from a taxable account or Roth IRA to cover living expenses could make more sense than an additional IRA distribution that would push MAGI into a new threshold for Medicare premiums.  Similarly, the Medicare cost of additional income should be considered when weighing the pros and cons of realizing large amounts of capital gains in a given year.

It is important to note that a specific IRMAA does not stay in place forever.  The determination is performed annually for Medicare beneficiaries, so if a participant has an unusually high-earning year due to realized capital gains or a large IRA distribution, the IRMAA owed for that year’s income will only last one year before reverting to the premium bracket based on the next year’s tax return.

Although a relatively small number of Medicare beneficiaries pay any IRMAA, it can cost a significant amount of extra money each year if incurred, especially by a married couple.  It is important to keep these break points in mind while tax planning for retirement income.  This can involve strategic management of retirement plan distributions as well as smoothing out of realized capital gains over multiple years to prevent a large spike in income.  Feel free to contact us with any questions about the IRMAA and how it could affect your situation.