Avoid­ing a Medi­care Hit

A hefty IRA can some­times mean higher health care costs. Don’t let this hap­pen to your clients.

Financial Planning - - CONTENTS - BY ED SLOTT

A hefty IRA can some­times mean higher health care costs. Don’t let this hap­pen to your clients.

With­out the right plan­ning, ac­cu­mu­lat­ing a large IRA can come with some un­ex­pected con­se­quences for clients, in­clud­ing higher Medi­care costs.

For­ward-think­ing ad­vi­sors can help by rec­om­mend­ing a num­ber of strate­gies to keep Medi­care costs in check, once clients take dis­tri­bu­tions from their IRAS and other re­tire­ment plans.

How does the sit­u­a­tion arise in the first place? Medi­care charges pre­mi­ums to par­tic­i­pants in Medi­care Part B, which cov­ers doc­tor vis­its, and Part D, the pre­scrip­tion drug ben­e­fit.

In 2018, the ba­sic pre­mium for Part B is $134 per month, while it varies for Part D de­pend­ing on the plan.

How­ever, high-in­come in­di­vid­u­als are re­quired to pay more. A high-in­come client, in this case, is de­fined as one with a mod­i­fied ad­justed gross in­come over $85,000 on a sin­gle tax re­turn, or $170,000 on a joint re­turn.

Th­ese clients’ pre­mi­ums are sub­ject to a sur­charge known as an In­come Re­lated Monthly Ad­just­ment Amount, or IRMAA. Th­ese sur­charges in­crease with in­come and can more than triple what Medi­care par­tic­i­pants pay for their ben­e­fits, cost­ing thou­sands of dol­lars each year.

In 2018, for ex­am­ple, the largest pre­mium sur­charges ap­ply to per­sons with MAGI over

If a client’s in­come spikes tem­po­rar­ily, for only one year, IRMAA sur­charges ap­ply ac­cord­ingly.

$160,000 on a sin­gle re­turn, or $320,000 fil­ing jointly. For Medi­care Part B, the largest sur­charge is $294.60 per month, or $3,535.20 per year.

This in­creases the monthly pre­mium to $428.60, which is 3.2 times larger than the base pre­mium of $134.

For Part D, the largest sur­charge is $74.80 per month, or $897.60 per year. Com­bined, the two sur­charges can to­tal $369.40 per month, or $4,432.80 per year.

In 2019, a new ad­di­tional in­come level of “over $500,000 sin­gle or $750,000 joint” will ap­ply.

A 6% Hike

Pre­mium amounts for 2019 will not be an­nounced un­til the end of 2018.

How­ever, as the sur­charge at the new over $500,000/ $750,000 in­come level will be set to col­lect 85% of plan costs, up from 80% at the cur­rent top level, the largest 2019 pre­mi­ums can be es­ti­mated to be about 6% larger than the largest are for 2018.

Th­ese IRMAA in­come thresh­olds are fixed through 2019. They’ll be ad­justed for in­fla­tion start­ing in 2020. IRMAA sur­charges ap­ply on a so-called cliff ba­sis. When

you reach the first dol­lar of an IRMAA in­come level, it causes the full cor­re­spond­ing sur­charge to ap­ply to all pre­mi­ums paid for the year.

Ex­am­ple 1: If Bob has MAGI of as much as $85,000 on his sin­gle re­turn, he’ll owe no sur­charge. But if his in­come reaches $85,001, then a monthly sur­charge of $53.50 for Part B plus $13.00 for Part D, or $66.50 to­tal, will ap­ply for all 12 months of the year. Bob’s $1 of ad­di­tional in­come in­creases pre­mium cost by $798 for the year.

You can help clients control in­come to min­i­mize sur­charges. For IRMAA pur­poses, MAGI is de­fined as Ad­justed Gross In­come (AGI) with ad­just­ments for some in­come that is ex­empt from fed­eral tax, such as in­ter­est from state and lo­cal bonds. Medi­care uses the MAGI re­ported on the fed­eral tax re­turn from two years ago.

For ex­am­ple, to de­ter­mine whether some­one will pay higher pre­mi­ums for 2018, Medi­care uses 2016 MAGI.

Sim­i­larly, the tax re­turn filed for 2018, which can be strate­gized for the rest of this year, will be used to cal­cu­late IRMAA sur­charges for the year 2020.

If in­come spikes tem­po­rar­ily, for only one year, sur­charges ap­ply ac­cord­ingly. This may re­sult from an event such as a large Roth IRA con­ver­sion, tak­ing a large in­vest­ment gain or even win­ning a lot­tery.

There is no “it’s only a one-time gain” ex­emp­tion to ow­ing a sur­charge. How­ever, if in­come drops the next year, then that year’s sur­charge will be re­duced ac­cord­ingly.

Be Aware of the RMD Ef­fect

Re­quired min­i­mum dis­tri­bu­tions can re­sult in much higher health care costs. Don’t for­get that this in­cludes older ben­e­fi­cia­ries who are sub­ject to RMDS on in­her­ited IRAS.

An RMD is in­cluded in the MAGI used to de­ter­mine Medi­care Part B and Part D costs two years later.

Ex­am­ple 2: Ja­son is sin­gle and reached age 70 ½ in 2016. He took his first RMD of $5,000 in 2016, in­creas­ing his MAGI to $108,000.

For 2018, his monthly Part B pre­mi­ums will be $267.90 (base pre­mium of $134 plus sur­charge of $133.90) and his Part D sur­charge will be $33.60 a month.

To avoid a cur­rent in­come spike from a Roth con­ver­sion, con­sider mak­ing a se­ries of par­tial con­ver­sions over many years.

With­out the RMD, his MAGI would be $103,000, so his monthly Part B pre­mium would be $187.50 with a Part D pre­mium of $13.00. That’s a com­bined $101 less.

In other words, Ja­son’s RMD will cost him an ex­tra $1,212 in 2018 for Medi­care ($101.00 x 12 = $1,212.00).

Check a client’s tax re­turn to see if re­ported MAGI is near one of the thresh­old amounts.

When MAGI is close to a thresh­old amount, take steps to keep it un­der the thresh­old. If in­come is close enough, any of a num­ber of tax re­turn strate­gies may do the trick.

Look­ing ahead, plan re­al­iza­tion of in­come and de­duc­tions to keep MAGI be­low the near­est thresh­old.

How Roth Con­ver­sions Can Help

A Roth IRA con­ver­sion can be use­ful in min­i­miz­ing fu­ture IRMAA sur­charges, as dis­tri­bu­tions from the Roth IRA can be tax free, re­duc­ing MAGI.

To avoid a cur­rent in­come spike from a Roth con­ver­sion, con­sider mak­ing a se­ries of par­tial con­ver­sions over a num­ber of years so in­come will not be pushed into higher tax brack­ets.

This is a strat­egy that re­quires long-term ad­vance plan­ning.

Clients who are in their early re­tire­ment years may want to con­sider con­vert­ing to a Roth IRA sooner rather than later. By do­ing so, they can min­i­mize the im­pact of RMDS on Medi­care costs. RMDS are not re­quired from Roth IRAS dur­ing the ac­count holder’s life­time.

When a client con­verts, the con­ver­sion is in­cluded in the MAGI used to de­ter­mine Medi­care Part B and Part D costs two years down the road. There­fore, clients will ideally want to con­sider con­vert­ing to a Roth IRA be­fore the ex­tra in­come would af­fect their Medi­care costs.

This is a strat­egy that should be dis­cussed with clients in their early 60s. As the ex­am­ples be­low show, think­ing ahead and do­ing the con­ver­sion be­fore it can im­pact Medi­care pre­mi­ums may save a client thou­sands of dol­lars.

Ex­am­ple 3: In 2015, Maria, age 62, be­came con­cerned about how fu­ture RMDS from her mil­lion-dol­lar IRA would af­fect her Medi­care costs.

She con­verted her IRA to a Roth IRA. The con­ver­sion is tax­able in 2015 and in­cluded in Maria’s MAGI for that year. How­ever, it will not af­fect Maria’s Medi­care pre­mi­ums, be­cause 2018 is the first year that Maria will par­tic­i­pate in Medi­care.

The MAGI re­ported on Maria’s 2016 fed­eral tax re­turn will de­ter­mine Maria’s pre­mi­ums for 2018.

By con­vert­ing in 2015, Maria avoids the fate of her con­ver­sion im­pact­ing Medi­care costs.

Ex­am­ple 4: Maria’s twin sis­ter, Kathy, gets wind of Maria’s suc­cess­ful strat­egy. She de­cides to con­vert her mil­lion-dol­lar IRA too, but de­lays do­ing so un­til 2016.

Her con­ver­sion is tax­able in 2016 and in­cluded in her MAGI for that year. Un­like her sis­ter, Kathy will see a big im­pact on her Medi­care pre­mi­ums.

This is be­cause 2018 is the first year Kathy will par­tic­i­pate in Medi­care, and the MAGI on her 2016 re­turn will

de­ter­mine the size of her pre­mi­ums. Con­vert­ing her mil­lion-dol­lar IRA in 2016 in­creases her MAGI to the high­est IRMAA in­come level.

For 2018, she will owe a Medi­care Part B pre­mium of $428.60 and Part D sur­charge of $74.80, monthly.

Con­vert­ing later may still be an ef­fec­tive strat­egy. A Roth con­ver­sion will neg­a­tively af­fect MAGI for Medi­care pur­poses for only one year. It may make sense to take that hit to elim­i­nate all RMD con­cerns in the fu­ture.

Ex­am­ple 5: Kathy from our pre­vi­ous ex­am­ple got hit hard with Medi­care costs in 2018 due to her con­ver­sion in 2016. How­ever, she will never have to take RMDS from her Roth IRA. She will avoid hav­ing RMDS in­crease her Medi­care costs in all years after she reaches age 70 ½.

Health Sav­ings Ac­counts

Younger clients may want to con­sider fund­ing an HSA rather than an IRA, if they have a choice. No one is ex­pect­ing the cost of med­i­cal ex­penses in re­tire­ment to de­crease.

Clients can make de­ductible HSA con­tri­bu­tions in their work­ing years, and then ac­cess their HSA tax- and penal­tyfree to pay for qual­i­fied med­i­cal ex­penses in re­tire­ment. This is the best of both worlds. Th­ese qual­i­fied dis­tri­bu­tions are not in­cluded in MAGI for Medi­care pur­poses.

Qual­i­fied Char­i­ta­ble Dis­tri­bu­tions

Qual­i­fied char­i­ta­ble dis­tri­bu­tions can also min­i­mize in­come. For older clients, QCDS may help min­i­mize the im­pact of an IRA on Medi­care costs. As a re­sult of the new tax law’s in­creased stan­dard de­duc­tion amounts, many clients won’t be de­duct­ing con­tri­bu­tions, so QCDS are more valu­able for in­come tax plan­ning. And they can help avoid Medi­care pre­mium in­creases as well.

With a QCD, an IRA owner (or ben­e­fi­ciary) who is age 70 ½ or older can trans­fer up to $100,000 an­nu­ally from their IRA to a char­ity, tax free.

A QCD can sat­isfy an IRA owner’s RMD for the year, and the RMD is never in­cluded in in­come at all, so it is not in­cluded in MAGI.

Keep­ing the RMD amount out of MAGI can re­sult in big sav­ings. This is not the case, how­ever, if an IRA owner takes an RMD and then do­nates to char­ity and claims a char­i­ta­ble de­duc­tion. With that ap­proach, the RMD would still be in­cluded in MAGI.

Ex­am­ple 6: Ja­son, from our prior ex­am­ple, de­cides to do a QCD of $5,000 to sat­isfy his RMD in 2016.

The $5,000 RMD is not in­cluded in the 2016 MAGI used to de­ter­mine his Medi­care costs for 2018. Ja­son’s QCD will save him $1,212 in Medi­care costs for 2018. If Ja­son had in­stead taken his RMD and made a char­i­ta­ble do­na­tion of $5,000, this would not have low­ered his Medi­care costs.

A client not us­ing QCDS to sat­isfy RMDS can start do­ing so and see ben­e­fits two years later. De­pend­ing on in­come lev­els, clients may ben­e­fit in some years but not oth­ers, but this strat­egy is worth look­ing into an­nu­ally.

If a client is char­i­ta­bly in­clined and would be mak­ing a do­na­tion any­way, why not do a QCD and save hun­dreds or even thou­sands in Medi­care costs, as well as in­come taxes?

As a re­minder, the QCD is only avail­able for IRAS, not com­pany plans. Also, donor-ad­vised funds and pri­vate foun­da­tions are not el­i­gi­ble re­cip­i­ents.

Other Strate­gies

Here are other ways you can help clients man­age MAGI to min­i­mize Medi­care sur­charges.

• Tim­ing in­vest­ment gains and other in­come by ac­cel­er­at­ing them onto a tax re­turn for a year be­fore IRMAA cal­cu­la­tions oc­cur, or de­fer­ring them to a year when in­come is ex­pected to be lower and there may be off­set­ting losses.

• Ob­tain­ing spend­ing funds from tax-free sources. For in­stance, a client may bor­row against a life insurance pol­icy rather than take a tax­able dis­tri­bu­tion from a re­tire­ment plan, or use tax-free pro­ceeds from the sale of a prin­ci­pal res­i­dence (as much as $250,000 for a sin­gle filer, or $500,000 on a joint re­turn).

• Home eq­uity is an­other source of tax-free cash, which can be tapped via a re­verse mort­gage (a home eq­uity con­ver­sion mort­gage). The HECM credit line can be drawn on tax-free, with no cor­re­spond­ing mort­gage pay­ment ex­pense.

• In­vest­ing in ap­pre­ci­at­ing as­sets and for tax-de­ferred in­come, rather than cur­rent in­come.

Clients ap­proach­ing their Medi­care el­i­gi­bil­ity years ob­vi­ously need plan­ning help. Ad­vi­sors can­not af­ford to be caught off guard when it comes to as­sist­ing th­ese clients.

Care­ful plan­ning with IRAS can help min­i­mize the bite of Medi­care costs. Roth con­ver­sions, HSAS and QCDS are all strate­gies worth dis­cussing with clients. An ad­vi­sor with ex­per­tise in th­ese mat­ters can stand out from the rest. FP

A client may bor­row against a life insurance pol­icy rather than take a tax­able dis­tri­bu­tion from a re­tire­ment plan.

Source: Medi­care.gov; anal­y­sis by Ed Slott & Co.

Break­down of Charges 2018 IRMAA sur­charges for Medi­care Part B and Part D

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