Close Close
Popular Financial Topics Discover relevant content from across the suite of ALM legal publications From the Industry More content from ThinkAdvisor and select sponsors Investment Advisor Issue Gallery Read digital editions of Investment Advisor Magazine Tax Facts Get clear, current, and reliable answers to pressing tax questions
Luminaries Awards

Retirement Planning > Social Security

Reducing Medicare Costs through Tax Deferral

Your article was successfully shared with the contacts you provided.

Healthcare costs are perpetually among the biggest challenges that retirees face. In a recent survey, three out of 10 retirees said that paying for healthcare costs was their single biggest financial concern.?

While most retirees count on Medicare during retirement, those with higher incomes pay proportionately more in Medicare premiums. Unlike other retirees, their Medicare costs can continue to rise even when Social Security cost-of-living increases (COLI) are frozen — as they were in 2010 and are again in 2011.

Financial advisors who can help higher-income retirees mitigate the rising costs of Medicare will find a growing and appreciative client base. A potential solution can be found by leveraging the simple power of tax-deferred annuities.

Why the Need?

Medicare Part B premiums represent the most common healthcare expense for most retirees. Medicare Part B functions similarly to traditional medical insurance, covering medically necessary services such as doctor visits, home health services and outpatient care. And like traditional medical insurance, the beneficiary must pay regular premiums.

Fortunately for most Medicare beneficiaries, the government pays a substantial portion of the Part B premium — about 75 percent — with the beneficiary paying the remaining 25 percent. However, that is not the case for retirees with higher incomes generated by Social Security payments, interest, dividends and other reportable sources.

Since 2007, higher-income Medicare beneficiaries have been required to pay a “means-adjusted” premium for Medicare Part B. In 2010, higher-income beneficiaries pay a Part B monthly premium equal to 35-80 percent of the total cost of Part B premium, depending on the income they report to the IRS. And “higher income” may not be as high you think. It’s defined as a single retiree with income above $85,000 per year, or a married couple with income above $170,000 per year. This is roughly equivalent to pre-retirement income of $106,250 (single) or $212,500 (married).2

According to the AARP, approximately 11 million beneficiaries are subject to these higher Part B premiums.3 And, because Medicare Part B premiums are recalculated every year, higher-income retirees could face escalating Medicare Part B premiums throughout retirement if their income grows due to investment earnings or cost-of-living increases.

Part B premiums for higher-income retirees also can increase even in years when there are no Social Security cost-of-living increases. Under current law, a “hold-harmless” provision is meant to protect retirees from Part B premium increases. The hold-harmless provision means that about 75 percent of Medicare beneficiaries don’t have to pay higher Part B premiums in years with no cost-of-living increase. But new retirees and higher-income retirees — who account for about 25 percent of Medicare beneficiaries — are not protected by the hold-harmless provision.

For the first time in 35 years, older Americans received no Social Security cost-of-living adjustments (COLA) in 2010, and they will see no COLA again in 2011.

What to Do?

Clearly, higher-income retirees are in a conundrum when it comes to Medicare costs. They face proportionately higher premiums with retirement income above the high-income threshold, and their premiums can continue to increase even if Social Security cost-of-living increases are frozen. One way to minimize this double-whammy is the tax-deferred annuity.

The taxable income figure used to determine the Medicare Part B premium amount includes ALL income from the client’s retirement accounts — including dividends, interest payments and capital gains that are not withdrawn.4 So, even if the retiree isn’t withdrawing money from his or her nest egg, the earnings from savings could be driving higher Medicare Part B premium charges.

By transferring all or a portion of their nest egg into a tax-deferred annuity, clients may reduce Part B premium costs by lowering their reported taxable income, since no deferred annuity income is reported for taxes until withdrawn. That leaves pension or retirement distributions and Social Security as their reportable income, which may leave clients below the “high-income” threshold and into the realm of the “hold-harmless” provision for Social Security cost-of-living freezes.

Let’s look at two retired couples — the Marlows and the Petersons — with identical incomes. Both rely on Social Security and retirement plan withdrawals as their primary income source, but the Marlows keep their nest egg assets in a taxable, interest-bearing account, while the Petersons have a tax-deferred annuity. The different strategies have a big impact on the amount of Medicare Part B premiums they owe.

The Marlows:

The Petersons:

Both age 68

Both age 68

Income used for living expenses each year: $150,000 — from retirement plans and Social Security

Income used for living expenses each year: $150,000 — from retirement plans and Social Security

Maintain nest egg savings in a taxable, interest-bearing account

Maintain nest egg savings in a tax-deferred annuity

Reported adjusted gross income of $180,000 from:

? Retirement plan withdrawals of $120,000

? Social Security income of approximately $30,000

? Taxable interest earned on savings of $30,000, re-invested as earned

Reported adjusted gross income of $150,000 from:

? Retirement plan withdrawals of $120,000

? Social Security income of approximately $30,000

85% of Social Security benefits are taxable

85% of Social Security benefits are taxable

Medicare Part B premiums: $3,713 per year

Medicare Part B premiums: $2,653 per year

The Petersons save $1,061 per year on Medicare Part B expenses because the tax-deferred annuity prevented $30,000 of interest earnings from being reported in adjusted gross income for the Medicare Income-Related Monthly Adjustment Amount. And, by moving assets from a taxable to a tax-deferred account, they reduce their federal and state income tax bills as well. It’s a simple solution that will save them a significant amount of money over the course of their retirement years.

Generate Income and Savings

As more baby boomers enter retirement age, advisors have an opportunity not only to help their clients generate dependable retirement income, but also to help them save money on healthcare — perhaps the largest recurring expense they will need to manage. A tax-deferred annuity is an effective tool for addressing both needs.

Liz Wilbur is the market research manager at Symetra Life Insurance Company.


© 2024 ALM Global, LLC, All Rights Reserved. Request academic re-use from All other uses, submit a request to [email protected]. For more information visit Asset & Logo Licensing.