Introduction
For many people annuities are a powerful tool to ensure a comfortable retirement. This guaranteed income is typically designed to supplement pensions and/or Social Security, thus creating a firm financial foundation in retirement. But what many may not consider is how this income may affect Medicare. Medicare is health insurance for Americans aged 65 and older. There are standard premiums for Parts B and D that many beneficiaries pay. However, depending on your income you may have to pay a surcharge called the income-related monthly adjustment amount or IRMAA. IRMAA is based on a sliding scale to adjust Medicare Part B and Part D prescription drug coverage premiums. The higher the beneficiary’s range of modified adjusted gross income (MAGI), the higher the IRMAA.
So how do withdrawals from an annuity impact Medicare premiums? Well that depends on the type of annuity. But first a primer on how MAGI is calculated.
How Does Medicare Calculate MAGI?
IRMAA thresholds are determined from the tax returns two years prior to the current year (e.g., 2024 MAGI is based on 2022 tax filings). From the tax filings, Modified Adjusted Gross Income (MAGI) is used to determine IRMAA costs.
Your MAGI is NOT a line item on your tax return but can be calculated from the items on the return. MAGI is the total of the following for each member of your household who’s required to file a tax return:
Adjusted Gross Income (AGI) on federal tax return (IRS Form 1040, Line 11)
Excluded foreign income
Nontaxable Social Security benefits (including tier 1 railroad retirement benefits)
Tax-exempt interest
Income from an annuity is typically included in your AGI.
Types of Annuities and their MAGI Impact
There are many types of annuities, immediate, deferred, variable, etc. But they all typically fall under two different categories: qualified and non-qualified.
A qualified annuity is funded with pre-tax funds or funds without tax treatments, such as contributions from IRAs, 401(k) accounts, or other tax-deferred savings.
In a non-qualified annuity, the money used to fund the annuity account comes from cash that has been declared to the IRS and has already been deducted.
The table below illustrates the difference between the two types of annuities and their impact on MAGI.
| Type | Tax Implication | Effect on MAGI |
|---|---|---|
Qualified | Tax deferred, qualified withdrawals are considered normal income and included in AGI. | Entire withdrawal will increase MAGI. |
Non-Qualified | After tax money is contributed, however, interest earned is taxed during withdrawal and included in AGI. | Only the interest earned will increase MAGI. |
Strategies to Mitigate Annuity’s Effect on MAGI
No matter what type of annuity is chosen, at some point it will influence MAGI. Utilizing non-qualified annuities is one way to reduce MAGI during the retirement years. However, there are several other strategies to mitigate this effect.
Splitting Up Annuities
If a beneficiary has a larger annuity and the insurance company allows for it, the beneficiary may be able to split the annuity into smaller parts. The smaller parts can be activated when needed to avoid the larger increase in MAGI. More control of your income stream gives you a better chance of avoiding IRMAA surcharges.
Timing of Withdrawals
Delaying or spreading out the withdrawal of an annuity can also be considered. Remember, IRMAA surcharges are calculated based on the tax filings from 2 years prior. If a beneficiary is early in their retirement, they may have been over an applicable IRMAA threshold during the last two years of their working career. It would be beneficial to delay annuity withdrawals until tax filings for the beneficiary’s retirement years (years of lower income) are used by the Social Security Administration (SSA).
Qualified Longevity Annuity Contracts
A qualified longevity annuity contract (QLAC) is a deferred income annuity funded with the assets from a qualified retirement plan. Since 2014 the federal government has allowed beneficiaries to fund deferred annuities with a portion of their retirement savings. The SECURE 2.0 Act allows individuals to move up to $200,000 from a qualified retirement plan to a QLAC. The benefit, so long as the QLAC complies with regulatory requirements, is that RMDs do not kick in until the owner turns 85. This is an extra 12 years a portion of a beneficiary’s retirement savings is not subject to RMDs. And because RMDs are calculated based on the balance of the applicable retirement accounts, you can lower your MAGI during those years after 73 thus further decreasing your chances of reaching IRMAA thresholds.
Conclusion
An annuity is a key tool that can be used to shore up a Medicare beneficiary’s retirement. But it’s important to consider the annuity type and how future withdrawals may affect income in retirement. This is one of the many questions to raise with any insurance company when researching annuities. Careful planning with a financial or retirement advisor can save thousands of dollars in Medicare premiums in the future.