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Portfolio > Economy & Markets > Fixed Income

Helping retirees dodge the Medicare income-based surcharge

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The complex rules governing Medicare income-based premium surcharges can increase higher-income clients’ health insurance costs by more than 200% percent during retirement. There are ways to alter a client’s investment mix to generate income that is excluded from Medicare’s income calculation, but the time to plan is now.

Medicare’s income-based surcharges are not currently indexed for inflation, and, because they can often take income earned in the years prior to retirement into account, a growing number of clients will find themselves facing higher-than-expected premium costs in retirement.

Fortunately, there are ways to alter a client’s investment mix to generate income that is excluded from Medicare’s income calculation, but because Medicare looks to income earned prior to retirement in determining whether the surcharge applies, the time to plan is now. medicare1. Medicare Income-Based Surcharges

Medicare income-based surcharges essentially increase the cost of premiums for Medicare Parts B and D for those clients who have modified adjusted gross income (MAGI) that exceeds $85,000 for individuals or $170,000 for married clients filing jointly. The surcharge is imposed based on a sliding scale, with the highest surcharge imposed upon single clients with MAGI exceeding $214,400 and couples whose MAGI exceeds $428,000.

While these income levels may seem relatively high for most retirees, they have not been adjusted for inflation since 2007 and have begun to impact a growing number of Medicare applicants, especially those who have not yet retired when they qualify for Medicare at age sixty-five.

Importantly, Medicare uses a two-year look-back period that is often overlooked by both clients and advisors.

The two-year look-back period means that the client’s MAGI from two years prior is used in determining whether the client is subject to the income-based surcharges in the current year. Because MAGI includes most types of traditional income—including wages, Social Security, IRA and 401(k) distributions, dividends, earned interest, and capital gains—the risk that a client will be liable for Medicare surcharges, at least in the early years of retirement, is very high.

Medicare Part B premiums and income-based surcharges are deducted from clients’ Social Security checks, meaning that without proper planning, the income that even your middle class clients have been counting on for retirement may be diminished. avoiding2. Planning Tools for Avoiding the Surcharge

The MAGI calculation used by Medicare to determine whether income-based surcharges will apply includes a wide range of income. For example, selling a house or receiving a bonus prior to Medicare qualification can push a client over the threshold. There are, however, types of tax-preferred products and vehicles that can help clients reduce their overall MAGI and potentially avoid the Medicare surcharges.

Income received on a tax-free basis in retirement is not included in calculating a client’s MAGI. This means that income drawn from after-tax retirement savings vehicles, such as Roth IRAs or Roth 401(k)s, is excluded from a client’s MAGI. Similarly, income drawn from a health savings account, which also allows tax-free savings to accumulate over the years, is excluded.

Further, income from tax-preferred financial products—such as annuity payments received from a nonqualified annuity or loans taken from a whole life insurance product—will not increase a client’s MAGI for Medicare means-testing purposes. health care3. Surcharges and health coverage

Medicare income-based surcharges can substantially increase the cost of clients’ health coverage at a time when their earning capacity is diminished. Advanced planning using after-tax savings vehicles and financial products can help your clients avoid an unpleasant surprise upon Medicare qualification.

(For more on Medicare planning, please see Under The Hood: Medicare Parts A, B, C and D—What You Need to Know, Pt. 1, and Factoring Medicare Part B Premiums Into Financial Plans.)


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