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That Extra Penny in Retirement Income Can Really Cost You

This post was originally published on this site

Money in a Roth IRA can be spent without pushing retirees into a higher Medicare premium bracket.



Photo:

Eve Edelheit for The Wall Street Journal

Here’s something most people nearing the age of 65 don’t know: Extra income in retirement—even as little as one penny—can mean much higher Medicare premiums.

Medicare has six income brackets that determine premiums, and going just a penny over an annual income threshold can cost you hundreds of dollars in additional premium expenses for a year.

“It’s a big surprise to a lot of people,” says financial adviser Megan Miller of Boulder, Colo., who adds that many clients assume Medicare will be free.

Fortunately, there are steps you can take to lower your income for Medicare purposes and thus avoid paying higher-than-necessary premiums. These include converting money from tax-deferred accounts to Roth IRAs, using qualified charitable donations that don’t show up on your income-tax statement, and asking the government for special consideration when your income drops from one year to the next.

Here’s how the Medicare math works. If you’re a single person with modified adjusted gross income up to $87,000, or a married couple with income up to $174,000, you will pay the basic Medicare premium this year of $144.60 monthly. (Part B premiums for 2021 haven’t been released yet.) But the premiums rise quickly. For a single person earning more than $163,000 and less than $500,000, or a couple filing jointly who earn above $326,000 and less than $750,000, the premium is $462.70 a month per individual.

Modified adjusted gross income is calculated by taking your adjusted gross income from your tax return and adding tax-exempt interest. Interest from municipal bonds, even though it’s not taxed by the federal government, can still push you into a higher Medicare premium bracket.

The premiums are higher for singles. Even if your income is in the lowest premium bracket as a married couple, it may be in a much higher one after your spouse dies and you are taxed as single.

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Income Based

The 2020 premiums for Medicare Part B medical coverage are based on a person’s modified adjusted gross income for 2018.

Income Thresholds

Monthly Medicare Part B premium

Single filers

Joint filers

$87,000 or less

$87,000.01 up to $109,000

$109,000.01 up to $136,000

$136,000.01 up to $163,000

163,000.01 to less than $500,000

$500,000 and above

$174,000 or less

$174,000.01 up to $218,000

$218,000.01 up to $272,000

$272,000.01 up to $326,000

$326,000.01 up to less than $750,000

$750,000 and above

$144.60

202.40

289.20

376.00

462.70

491.60

Income Thresholds

Monthly Medicare Part B premium

Single filers

Joint filers

$87,000 or less

$174,000 or less

$144.60

$87,000.01 up to $109,000

$109,000.01 up to $136,000

$136,000.01 up to $163,000

163,000.01 to less than $500,000

$500,000 and above

$174,000.01 up to $218,000

$218,000.01 up to $272,000

$272,000.01 up to $326,000

$326,000.01 up to less than $750,000

$750,000 and above

202.40

289.20

376.00

462.70

491.60

Income Thresholds

Monthly Medicare Part B premium

Single filers

Joint filers

$87,000 or less

$174,000 or less

$144.60

$87,000.01 up to $109,000

$109,000.01 up to $136,000

$136,000.01 up to $163,000

163,000.01 to less than $500,000

$500,000 and above

$174,000.01 up to $218,000

$218,000.01 up to $272,000

$272,000.01 up to $326,000

$326,000.01 up to less than $750,000

$750,000 and above

202.40

289.20

376.00

462.70

491.60

Note: There are separate thresholds for married people filing separately.
Source: Medicare.gov

Suppose a couple had modified adjusted gross income of $170,000 from Social Security, pensions and required minimum distributions from their tax-deferred accounts. That’s under the limit for the standard Medicare premium, and the couple will each pay $144.60, or a total of $289.20, a month.

The picture changes dramatically when the husband dies. The smaller of their two Social Security checks stops, but the pensions and RMDs continue, and the wife now has income of $155,000 a year. That puts her into the third-highest Medicare bracket as a single taxpayer, where she must pay $376 a month for Medicare. She is paying 30% more to cover herself as a single person than she and her husband were paying to cover both of them. And she will have to pay a $50.70 surcharge for her Medicare Part D drug coverage on top of that because of her income.

So, what can you do? Here are some maneuvers that accountants and financial advisers use to avoid or cushion the financial blow of higher Medicare premiums.

Reduce distributions from tax-deferred accounts

The government now requires that you begin making distributions from taxed-deferred accounts at age 72. While RMDs have been halted this year because of the pandemic-induced recession, they will return next year.

Many upper-income retirees have bulging individual retirement accounts, and RMDs are a big reason they end up paying higher Medicare premiums.

The best way to avoid high RMDs is to begin reducing tax-deferred accounts well before age 72. Often, people who have just retired and haven’t yet begun taking Social Security are in a low tax bracket for several years. That makes it an ideal time for Roth conversions, in which money in tax-deferred accounts is converted into after-tax Roth account money. People doing Roth conversions must pay income taxes on each dollar they convert so it makes sense to do conversions when they’re in a lower tax bracket.

Roth conversions will reduce the balance in your tax-deferred accounts, thus lowering your RMDs. And you’ll end up with a stash of financial assets in the Roth, which can be spent without pushing you into a higher Medicare bracket.

Roth conversions likely don’t make sense for those who have already begun drawing down tax-deferred accounts. But everyone should keep their Medicare brackets in mind nonetheless.

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Marianela Collado, a certified public accountant in Plantation, Fla., says she works with a California couple who pull $10,000 out of their tax-deferred accounts each month, an amount in excess of their RMDs. In some years, she says, the couple is able to lower their tax withholding for the last month or two without running afoul of IRS rules. That allows them to take out less than $10,000, which keeps them out of a higher Medicare bracket.

People on the brink of being pushed into a higher Medicare bracket can frequently dodge the bullet by pulling money out of an after-tax account or Roth IRA for a month or two instead of a tax-deferred account. Or they can defer an expense like a car purchase until the next year.

“You don’t want the tax tail to wag the dog,” Ms. Collado says. “But you may hold off on an IRA distribution that could adversely affect your tax situation.”

Make a qualified charitable deduction

People with charitable intentions can score a double-win by donating straight from their tax-deferred account. A qualified charitable deduction can replace up to $100,000 of their RMD, reducing the income that determines their Medicare bracket.

You must be at least 70½ to use this tax break.

Don’t forget that the donation must come straight from your tax-deferred account to pass muster with the Internal Revenue Service.

“You don’t want to take the money out of our 401(k), put it in the bank, and write a check,” says William Reichenstein, head of research for Social Security Solutions Inc. and finance professor emeritus at Baylor University.

Instead, ask the manager of your account to draft a check straight to the charity. Some account custodians will issue checkbooks linked to your IRA so that you can write the check to the charity yourself and still qualify.

Ask the government for relief

The Social Security Administration, which administers Medicare, realizes that there are life events that lower seniors’ incomes. Suppose an executive retires midway through 2018 but still has high income that year from salary, bonuses and exercising stock options. She goes on Medicare in 2020.

Medicare looks at income from two years earlier to determine a person’s premiums. So her 2020 premiums would normally be based on her 2018 income. However, she can file a form and ask for the government to base her premium on her much lower expected 2020 income.

The government is pretty good about granting relief for qualifying life events such as deaths, divorces, retirements, loss of work and even loss of income from income-producing properties.

Some things don’t count. For example, if a retiree has a big capital gain one year from an asset sale, that could push him into a higher Medicare bracket two years later. The good news is that it’s a one-time event, and when his income drops back, so will his Medicare premium.

Mr. Templin is a former reporter and editor for The Wall Street Journal who lives in New Jersey. He can be reached at reports@wsj.com.

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