Introduction
This is part three of a series focusing on income-related monthly adjustment amount (IRMAA) surcharges and Medicare. The first two articles focused on what IRMAA was and whom it applied to, while the second article discussed strategies for reducing or avoiding IRMAA. This article is a wider discussion of IRMAA in relation to retirement planning.
According to Fidelity’s Retiree Health Care Cost Estimate, the average couple can expect to pay about $315,000 (after tax) for health care costs in retirement (Fidelity Wealth Management, 2024). This does not include the cost of long-term care if needed, which can easily top six figures per year.
As discussed in previous articles IRMAA surcharges, depending on the beneficiary’s modified adjusted gross income (MAGI), can add thousands of dollars per year to premiums. Given the rising costs of health care it is important to understand some basic principles to better plan for the costs of Medicare.
Medicare Basics (Department of Health and Human Services, 2024)
Medicare is an important component of retirement planning. Medicare is health insurance for Americans 65 and older and consists of four parts: hospital visits (Part A), medical services (Part B), Medicare Advantage Plans (Part C) and prescription drug coverage (Part D).
| Parts | Description |
|---|---|
A | Helps cover inpatient care in hospitals, skilled nursing facility care, hospice care, and home health care. |
B | Helps cover:
|
C | Medicare Advantage is a Medicare-approved plan from a private company that offers an alternative to Original Medicare for your health and drug coverage. These “bundled” plans include Part A, Part B, and usually Part D. |
D | Helps cover the cost of prescription drugs |
When your MAGI reaches a certain threshold (on a sliding scale) IRMAA surcharges will be applicable to premiums on Parts B and D.
Impact of Withdrawals on IRMAA
When planning for retirement, there are generally two types of accounts: pre-tax and post-tax. Traditional 401(k)s and IRAs use pre-tax money, reducing your taxable income and current tax burden. The money grows tax-free but is considered "tax deferred," meaning withdrawals are taxable. Roth 401(k)s and Roth IRAs use post-tax money, which means you've already paid taxes on the funds, and the money grows tax-free. Withdrawals from these accounts are not taxable.
Withdrawals during retirement can impact the Income-Related Monthly Adjustment Amount (IRMAA). Withdrawals from traditional accounts are included in the MAGI calculation, potentially increasing your MAGI and triggering IRMAA surcharges. In contrast, Roth account withdrawals do not increase your MAGI.
To avoid IRMAA surcharges, you can focus on investing in Roth accounts or consider a Roth conversion ladder. This strategy involves converting funds from traditional accounts to Roth accounts over several years, minimizing the tax burden in each year. A financial planner or tax advisor can help ensure the tax burden during conversions does not exceed potential IRMAA surcharges after Required Minimum Distributions (RMDs).
Managing Income in Retirement
As part three of this series discussed in detail, the primary means of avoiding or reducing IRMAA surcharges is controlling your MAGI. There are other income streams in retirement which can also help maintain a lower MAGI or reduce the potential increase.
Annuities and reverse mortgages are tools that can be considered when planning for retirement since portions of those funds can be non-taxable. For more information on these tools see part three of this series.
Another consideration for managing income in retirement is the timing of when to take social security. Social security benefits can be claimed for as early as 62 years old or as late as 70. Every year you wait after 62 until full retirement age (FRA), the benefit increases. And every year you wait after FRA increases the benefit increases 8% per year until age 70 when the benefit is maxed out (except for COLA). Social security is included in the MAGI calculation.
Therefore, when to claim social security should be considered in your overall costs in retirement.
Conclusion
Proactive retirement planning is vital to managing healthcare costs and Medicare expenses, including IRMAA surcharges. Understanding the impact of MAGI on premiums and strategically using Roth accounts and possibly other income streams (annuities and reverse mortgages) can help minimize these costs. Additionally, timing your Social Security benefits carefully can also optimize your retirement income. Consulting with a financial planner can provide personalized strategies to ensure a secure and cost-effective retirement.
The next part in this series will delve into the details of appealing IRMAA.
References