Executive Summary
Since 2007, higher-income individuals and couples have been required to pay an additional income-related monthly adjustment amount (IRMAA) on their Medicare Part B premiums; a similar rule took effect in 2011 for Medicare Part D premiums. The ultimate impact can potentially be significant; although only a small number are affected, those at the highest income levels in 2015 (used to determine premiums in 2017) will see their Medicare Part B premiums rise from a base of $134.00/month up to $428.60/month. (Notably, though, those eligible for the "hold harmless" rules will have Part B premiums capped at $109.00/month for 2017.) In addition, Part D premiums will cost as much as an extra $72.90/month in addition to the base rate of the plan itself, under the IRMAA rules.
Although the higher premium amounts are a cost, because they're determined based on income and may change from year to year, they effectively equate to an "indirect tax" in the form of a higher burden on higher income levels. In turn, this means that the income thresholds for Medicare Part B and D premiums should itself be treated as a "tax bracket" that can be planned and managed around, as a form of proactive income tax planning. Strategies that might create income, or defer income resulting in a greater concentration down the road, must be evaluated for not only their outright tax consequences, but their indirect tax consequences in the form of higher Medicare premiums!
(Michael's Note: This article has been updated for the upcoming 2017 Medicare Part B and Part D premium surcharges under the IRMAA rules. See here for further detail on the new IRMAA brackets that take effect beginning in 2018.)
Income-Related Monthly Adjustment Amounts (IRMAA)
For higher-income individuals and couples, Medicare Part B and Part D premiums are adjusted upwards beyond the base cost that generally applies for most. Although current estimates are that fewer than 5% of Medicare recipients are actually affected by the income thresholds, the increases can nonetheless be significant.
For Part B, the intention of the rules is that while most people pay about 25% of the true cost of Medicare - the Federal government covers the other 75% - for higher income individuals, the cost-sharing rises from only 25% to 35%, 50%, 65%, and ultimately 80% as income increases. In the case of Part D, the cost of plans varies by state and plan selected, so higher-income individuals simply pay a flat additional amount. These higher costs - for both Part B and Part D - are withheld directly from the individual's Social Security check, although a separate bill will be sent to those impacted if they are not yet received Social Security benefits (even though the base cost of Part D is normally paid directly to the insurance provider, not the Federal government).
The chart below shows the amount of these "surtaxes" as income rises, using the thresholds that will apply in 2017. The income thresholds above are based on "Modified" Adjusted Gross Income, where the "modification" is to add any tax-exempt bond interest to the individual's current AGI. The adjustments are applied each year based on the individual's most recent tax return; as a result, there is generally a one-year lag in the process. For instance, because 2015 tax returns have only just been filed, Medicare premiums in 2017 will be based on that 2015 tax return; the return that will soon be filed for 2016 (in early 2017) will be used to determine Medicare premiums for 2018, and so forth.
| Individual MAGI | Married Joint MAGI | Part B Premium (monthly) | Part D Premium (monthly) | Total Surcharge (monthly) |
| < $85,000 | < $170,000 | $134.00 | Plan premium | N/A |
| Up to $107,000 | Up to $214,000 | + $53.50 | + $12.70 | + $66.20 |
| Up to $160,000 | Up to $320,000 | + $133.90 | + $32.80 | + $166.70 |
| Up to $214,000 | Up to $428,000 | + $214.30 | + $52.80 | + $267.10 |
| > $214,000 | > $428,000 | + $294.60 | + $72.90 | + $367.50 |
If you receive an IRMAA Determination Notice but the reality is that income has gone down - i.e., the individual's 2015 tax return showed substantially higher income than what he/she is actually experiencing in 2016 - it's possible to contact the Social Security Administration (which oversees this Medicare premium process) to request an adjustment. Situations that may be considered for changes in income include if the client:
- Got married, divorced, or widowed;
- Stopped working or reduced work hours;
- Lost income-producing property due to a disaster or other event beyond control
- Experienced a cessation, termination, or reorganization of an employer pension plan
- Received a settlement because of an employer's closure, bankruptcy, or reorganization
Notably, large one-time income events, such as a Roth conversion, or a liquidation that triggers a significant capital gain, are not necessarily eligible for an exception from the higher premium rules, although since the income thresholds for Medicare premiums are re-evaluated annually, a temporary or one-time event would likely only result in higher Medicare premiums for a single year. Nonetheless, exceptional circumstances outside the list above can be challenged by filing a Request for Reconsideration (Form SSA-561-U2) with the Social Security Administration.
Marginal Consequences Of Medicare Premium Thresholds
So what are the practical consequences of these Medicare premium thresholds on various planning strategies?
Imagine a single retired individual in 2016 who is in her mid 60s and has $60,000 of Adjusted Gross Income, reduced by a $7,850 standard deduction (including the over-age-65 amount) and a $4,050 personal exemption down to $48,100 of taxable income after deductions, which places her in the 25% individual tax bracket. She decides that a partial Roth conversion would be a good idea, to whittle down her IRA so the RMDs that begin in a few years won't drive her into an even higher tax bracket. As a result, she decides to convert $43,050, which will bring her right up to the upper 25% tax bracket threshold of $91,150. The estimated tax impact would be 25% (current tax bracket) x $43,050 (conversion amount) = $10,762.50.
However, given a $60,000 AGI, adding another $43,050 would cross the first IRMAA threshold for individuals, resulting in an additional $53.50/month of Medicare Part B and Part D premiums that will be due in 2018 (based on the tax return she'll file in 2017 for the income she earns in the current 2016 tax year). This will result in a total of $642.00 of premiums as a result of her Roth conversion, which brings the true total liability of the Roth conversion to $10,762.50 (taxes) + $642.00 (additional Medicare premiums) = $11,404.50. Given a Roth conversion of $43,050, this means the true marginal tax rate that applied to the conversion was not 25% (the tax bracket), but $11,404.50 / $43,050 = 26.5%. In other words, the Medicare premium adjustment was the equivalent of an extra 1.5% surtax on the Roth conversion.
Planning Around Medicare Premium Increases
While the surtax due to higher Medicare premiums that resulted from the Roth conversion was not huge, at only 1.5%, it nonetheless represents an entirely manageable - and potentially avoidable - surtax that planners and retirees should carefully consider.
For instance, the individual might have decided to convert only $25,000 in the prior example - rather than $43,050 - to keep from exceeding the $85,000 AGI threshold that triggers the first Medicare premium increase, allowing the conversion to have a cost of "only" the 25% marginal tax bracket, and not 26.5%. On the other hand, if the retiree's income was higher, the impact would have been more severe. For instance, if AGI was already right at (but not over) $85,000, then a $5,000 conversion would result in $1,250 of taxes (at a 25% tax) plus the same $642.00 (for additional Medicare premiums), which leads to a marginal "tax" of $1,892.00 and a marginal tax rate of 37.8%; on the other hand, if the conversion was $10,000, the marginal rate would only be 31.4% (since the additional taxes would rise to $2,500 but the Medicare premium impact would still be the same $642.00/year). The end result: the closer retirees are to an income threshold (without already crossing it), the better it is to either stay right below the line, or rise far above it until the next threshold (or a new tax bracket) approaches, because the additional Part B and Part D premiums are a flat additional amount even if the individual is just $1 across the line (unlike tax brackets, which are always a percentage of additional income). And because the premium adjustments are calculated based on AGI, anything that increases AGI can impact exposure, from IRA withdrawals and Roth conversions, to capital gains, to dividends and interest and income from pass-through entities; on the other hand, any deductions that are taken above the line, such as capital losses or certain business losses, can also reduce exposure.
Notably, the challenge of planning for a potential increase in Medicare premiums will loom larger and larger for clients over time, due to the fact that the Patient Protection and Affordable Care Act eliminated any inflation adjustments on the premium thresholds between 2011 and 2019 (and was also the legislation that added Part D premium increases for higher income taxpayers based on the Part B income thresholds). As a result of the loss of any inflation adjustments for a decade, the impact of inflation on income will cause more taxpayers to become subject to the tax over time; a recent analysis from the Kaiser Family Foundation estimates that exposure for Part B premium increases will climb from approximately 5% of individuals in 2011 to 14% by 2019 (the Part D impact is estimated at 3% in 2011, rising to 9% by 2019; the impact is lower because not everyone enrolled in Part B has also enrolled in the optional Part D, and some higher income taxpayers continue to receive prescription drug coverage from a former employer). And notably, IRMAA has additional adverse effects in low-inflation environments - because those who are subject to IRMAA do not receive the protection of the "Hold Harmless" rules on Medicare Part B and Part D premium increases if the Social Security Cost-Of-Living Adjustment (COLA) is negative for the year!
The bottom line is that with the potential premium adjustments on Medicare Part B and Part D as income rises, tax planning for retirees requires both managing income around the Medicare income thresholds, as well as other factors like the tax brackets themselves, the phaseout of itemized deductions and personal exemptions (at $250,000 of AGI for individuals and $300,000 for married couples) that changed beginning in 2013, and the new Medicare surtaxes on employment and investment income (at $200,000 of AGI for individuals and $250,000 for married couples). While the marginal tax rate impact may not be huge for most strategies (although it can be much larger for clients close to a threshold who just barely cross it and add a flat additional premium amount), it still represents an indirect tax that impacts the relative benefit of planning strategies, and should be planned for accordingly!
