Introduction
When shopping for annuities there are a myriad of options available. And not only are there many options (and insurance companies offering them) but the right annuity also depends on your personal circumstances. One of those circumstances is the cost of Medicare and income planning to avoid IRMAA thresholds.
This article focuses on two types of annuities and how they affect Medicare costs and IRMAA and which one may be better for a beneficiary in retirement.
Definitions
An annuity is a contract between you and an insurance company. In exchange for a lump sum or a series of payments, the company promises to provide you with a steady stream of income either immediately or at some point in the future.
An immediate annuity is a financial vehicle designed to provide a steady stream of income in exchange for a lump sum payment. A generally popular choice for retirees providing a solid income foundation to go along with any pensions and Social Security.
A deferred annuity brings the same type of advantages as a traditional IRA. You can either fund it with a lump sum payment or a series of payments.
Comparison (Egan, 2024)
For both the immediate and deferred annuity there are no contribution limits, unlike retirement accounts such as 401k’s or IRAs.
| Annuity Type | Payments Received | Accumulation Phase | Funding Options | Payouts | Returns |
|---|---|---|---|---|---|
Immediate | Within 12 months of contract purchase | Shorter | Lump sum payment | Within 12 months of contract purchase | Less, due to shorter accumulation phase |
Deferred | At least 12 months after contract purchase | Longer | Lump sum or series of payments | Delayed at least 12 months after contract purchase | Tends to be higher depending on length of accumulation phase |
For both the immediate and deferred annuity there are no contribution limits, unlike retirement accounts such as 401k’s or IRAs.As can be seen, immediate annuities will have a shorter accumulation phase and sooner payout (with smaller returns typical). A deferred annuity may have a longer accumulation phase with payouts that could be years down the road and the associated interest growth.
One other consideration that should be mentioned is whether the annuity is a qualified or non-qualified annuity. Simply put, qualified annuities are funded with pre-tax dollars. This means that the contributions and growth are taxed upon withdrawal. While non-qualified annuities are funded with after-tax dollars. This means that the contributions are not taxed when withdrawn, but the growth is. Both an immediate or deferred annuity could be qualified or non-qualified.
Effect on MAGI
Timing
Timing the payouts of an annuity is a key consideration in income planning during retirement. Each person’s income plan will differ and an example may be helpful to illustrate how to think through the timing of an annuity.
Let’s say it’s the year you turn 65 and you plan on retiring. Your combined household MAGI is just below the projected IRMAA threshold for that year and has been for the last two years. This would mean that you would not be subject to IRMAA surcharges the year you claim Medicare benefits. If you were thinking of buying an annuity the same year, you would most likely want to consider a non-qualified deferred annuity with at least a two-year payout date. The Social Security Administration (SSA) uses IRS tax filings two years prior to the current year (e.g., 2022 tax returns to determine 2024 IRMAA surcharges). At 67 years old the SSA will still be using tax returns from the last year you were working. If you had purchased an immediate annuity that year and started receiving payments, you may well have reached the IRMAA threshold for surcharges. By delaying the annuity payout, you were able to either partially or completely avoid IRMAA surcharges.
This is a simple illustration and there will be other factors to consider. It is recommended to work with a financial/retirement professional to create a plan that works for you.
Withdrawals
As previously discussed, withdrawals from a qualified annuity will be included as normal income and taxed accordingly. For non-qualified annuities, the contributions are not taxed when withdrawn but the interest earned is. This could greatly decrease the taxable income for a beneficiary during retirement.
Conclusion
So, is an immediate annuity or deferred annuity better for IRMAA and Medicare costs? The answer: it depends. Personal finance is exactly that: personal. Given the plethora of annuity options available on the market today and the circumstances a beneficiary may be in, there is no one right answer to the question given. But in general, someone who may have more traditional IRA or 401k retirement savings with some Roth accounts may benefit from the deferred annuity if they decide to do a Roth ladder conversion. Someone relying mostly on a government pension and Social Security may be better off with a non-qualified annuity to minimize the taxable event during the payout period of the annuity.
These and many other scenarios could be analyzed to determine the best fit for a beneficiary. Be sure to discuss your specific situation with a qualified and trusted financial advisor.
References
Egan, J. (2024, August 14). Retirement. Retrieved from Forbes Advisors Website: https://www.forbes.com/advisor/retirement/immediate-vs-deferred-annuity/