Will Medicare Surcharges Affect You in Retirement?

If you have never heard the term “Medicare Surcharge” consider yourself in the majority. For starters, if you aren’t retired and on Medicare then it doesn’t affect you yet. In addition, it only impacts retired individuals, or couples, above certain income thresholds. Finally, even if you can check those boxes you might not have noticed, or understood, why your Medicare part B & D premiums were more expensive than anyone else’s. After all, you probably have the premiums deducted straight out of your Social Security check. Out of sight, out of mind.

The Medicare Surcharge, or IRMAA for short (income-related monthly adjustment amount), impacts roughly 7% of Medicare enrollees, making it a relatively obscure tax and easy to be surprised by. Regardless, it is better to be safe than sorry so we will briefly discuss its origins, who it impacts, and ways to avoid it.

Where did IRMAA come from?

In 2003, Congress passed the Medicare Prescription Drug, Improvement, and Modernization Act. This is the same law that established Medicare part D (prescription drug coverage), HSA accounts, and Medicare Advantage under part C. It was one of the largest changes to the Medicare system since its inception in 1965.

IRMAA was designed to shore up funding for Medicare and applied to high income enrollees of Medicare part B. It was later expanded in 2011, as part of the Affordable Care Act, to include high income enrollees of Part D. The government pays, on average, about 75% of a Medicare premium cost and the recipient covers the remaining 25%. IRMAA was a way to shift 35-85% of the cost, instead of 25%, back to enrollees and hold off cuts to Medicare.

Who does the Medicare Surcharges Affect?

As we mentioned before, IRMAA only affects Medicare enrollees in certain income ranges. If you cross the income thresholds by even $1, a tiered adjustment applies effectively raising your cost for Medicare. The adjustment amount is often deducted directly from your Social Security check, just like your Medicare premium would be. Here are the new income brackets and premium increase amounts for 2020:

If you are keeping score at home it means that once you cross $87,000 of income, or $174,000 if filing jointly, your monthly Medicare costs increase by $70.00 a month, or $840 a year, per enrollee. For a married couple that adds up to $1,680 a year in unplanned expenses. Extrapolate that over a retirement lifespan of 25 years and you’ve lost $42,000 without even accounting for inflation.

As you would expect, there are even more wrinkles in figuring out if it applies to you. First, you need to know your modified adjusted gross income, or MAGI because that is the figure used to determine where you land in the brackets. However, don’t calculate this year’s MAGI, look back two years. Medicare looks at your MAGI from two years prior to determine any adjustments. This is another reason why it is easy to miss with increasing or lumpy retirement income. It won’t affect you the first year your income crosses the threshold but waits two years to rear its ugly head.

Ways to avoid IRMAA

The good news is that techniques for sidestepping the Medicare surcharge are very similar to traditional tax minimization methods. Besides keeping a keen eye on the income brackets, which will adjust every year after 2020 for inflation, being able to control your sources of income is critical. We believe the easiest way to do that is having access to enough tax-free income, like from a Roth IRA.

When you can create an income stream from both taxed and tax-free sources it can help maintain your standard of living while keeping you below some of the thresholds we mentioned earlier. The two most common methods of building up a Roth account are through funding a Roth IRA, or Roth 401(k),
throughout your working years or to convert traditional IRA funds to a Roth IRA. Since initiating a Roth
conversion increases your taxable income in that year spreading it out may make sense. This might be done by small incremental conversions over time or choosing to make larger Roth IRA conversions in years where income is abnormally low, or tax deductions are abnormally high.

For those who have very large looming Required Minimum Distributions, doing Roth conversions also
helps to lower that future requirement and provides more control over their income sources. We feel
this may be a powerful strategy when carefully planned. If you are lucky enough to not need to spend all or part of your RMD for living expenses you could consider a Qualified Charitable Distribution. A
qualified charitable distribution is an otherwise taxable distribution from an IRA owned by someone over age 70½ that is paid directly from the IRA to a qualified charity. By paying all or part of the RMD amount directly to a charity it is not counted as taxable income to you and therefore not subject to IRMAA calculations.

Finally, since your income calculated for IRMAA follows a two-year look back, you may no longer be at
the same income levels today that you were then. Thankfully the Social Security Administration has a
form (#SSA-44) where you can report a life changing event (like death of a spouse, work stoppage, or
divorce) that caused your income to decrease so you can avoid the additional cost. While IRMAA only impacts a small percentage of Medicare recipients, it is any easy expense to slip through the cracks unnoticed. With early and careful planning many of those affected can help mitigate the impact it has on their retirement budget.