Medicare Surcharge – What to Do

Reaching Medicare eligibility solves one of the most expensive retirement problems for many retirees: healthcare. Once you’ve made the adjustment and selected all the various Parts and plans, the convenience and affordability of Medicare are one of the benefits of turning 65. However, Medicare is means-tested. If you make over a certain amount of income, surcharges on the Medicare Part B and Part B premiums kick in.

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Making it a little more painful, it’s not a flat increase. The surcharges go up as incomes get higher and at the highest level can amount to hundreds of dollars a month in additional costs.

The key to avoiding or minimizing the surcharge is to control income levels. In early retirement, this may be reasonably easy to do. But if you’ve amassed a retirement nest egg in a traditional tax-deferred 401(k) or IRA account, once you hit 72 and required minimum distributions (RMDs) kick in, you can find yourself with a very hefty bill.

What is the IRMAA?

Medical insurance (Part B) and prescription drug insurance (Part D) are paid by a combination of the federal government (75%) and a premium paid by a Medicare enrollee (25%.) The IRMAA, which stands for Income-Related Monthly Adjustment Amount, is a surcharge applied to the Part B and Part D premium.

It’s calculated by the social security administration, using the most recent data available from the IRS. The social security administration will notify you if your income level triggers a surcharge. The cooperation between these two government agencies means a two-year look back, as the SSA gets data directly from the IRS and builds in a lag time to allow for returns to be processed. In practice, your 2023 Medicare IRMAA is calculated on your 2021 income.

Right away, you can that some problems might arise. If you work right up until Medicare begins at age 65, your income from work might trigger the surcharge before your income gets lower in retirement. There is a remedy. You can request a “new initial determination” to get the SSA to recalculate your surcharge. There are five qualifying instances for this:

  1. An amended tax return since original filing
  2. Correction of IRS information
  3. Use of two-year-old tax return when SSA used IRS information from three years prior
  4. Change in living arrangement from when you last filed taxes (e.g., filing status is now “married filing separately,” but you previously filed jointly)
  5. Qualified life-changing event(s)

Number five, the “qualified life-changing event,” would be the one that would cover a work stoppage.

Managing Retirement Income With an Eye to IRMAA

The IRMAA is calculated on your Modified Adjusted Gross Income, which is your AGI plus certain interest income. So, the key is to maintain as low a taxable income as possible. Since, for many people, income in retirement comes from withdrawals to investment accounts, that’s the first place to think about minimizing the IRMAA.

Liquidating high-basis investments you have held for more than a year may lower taxes. The investments will not have appreciated as much, and you’ll be paying the lower long-term capital gains tax on any increase in value. High-basis investments may often be bonds, so you’ll want to be careful not to create a situation in your allocation where you are liquidating your lower-volatility assets and potentially exposing yourself to more risk.

At age 72, your RMDs will begin, and they can be hefty. The first year of RMDs on a $1 million portfolio can be as much as $40,000. You can avoid RMDs altogether by converting some or all of your traditional tax-deferred retirement savings accounts to Roth accounts before Medicare kicks in. You’ll need to plan carefully, but using the funds as a sole source of income can also help you delay taking social security benefits, which will increase the amount you receive.

The Bottom Line

Medicare is a great way to access healthcare in retirement, but many moving pieces need to be considered like all the other retirement decisions. Planning ahead, thinking it through with a tax lens, and including social security benefits in your planning can help you maintain the income you need and minimize the taxes you pay.



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