While everyone is staring at the Patient Protection and Affordable Care Act (PPACA or Obamacare, pick your poison) and trying to decipher how it will actually impact them, the fact of the matter remains that yet another year has passed without a single shred of attention placed on legislation that was already passed decades ago — legislation that will impact everyone who retires and collects Social Security.
I bet you don’t even know what pieces of legislation I’m talking about. They are:
1. The Program Operations Manual System of Social Security in 1993
This manual dictated that not only is Social Security an entitlement, but Medicare is, as well. This “entitlement” status has ultimately led the courts to decide that, in order to receive a Social Security benefit, a person must also accept Medicare when eligible — meaning they can no longer be covered by credible health insurance through an employer (or spouse’s employer). Translated into layman’s terms, this means that anyone who is retired and receiving a Social Security benefit must accept Medicare, as well.
This may not seem like a big deal in and of itself, but when we take a step back and look at the bigger picture, the problem comes into focus, especially when we consider the following.
2. The Medicare Modernization Act of 2003
This piece of legislation created Medicare Advantage plans, as well as Part D prescription drug coverage. However, its most important feature is that it also paved the way for Medicare to be means-tested. For the uninitiated, means-testing is a method of assessing your eligibility for Medicare — and requiring those with more assets to pay more of their overall health care costs.
While this may not seem like such a big deal to some clients, it will seem like a lot of money for others; especially after they reach the age of 70 and have to, under federal law, annually withdraw a required minimum distribution (RMD) from their tax-deferred savings. This withdrawal, along with practically every other asset that can be used for income in retirement (with the exception of instruments like Roth IRAs and life insurance), will be used to determine how much income a person is making in retirement — and the more they make, the more they will pay.
Currently, the penalties range from 40 percent to more than 220 percent for those individuals earning over $85,000 or married couples earning over $170,000. But never fear, Congress is well aware of this problem and is acting accordingly. They are currently debating on which one of three proposals to use to fix this issue. Sounds good, right?
Well, there’s some bad news. All of the proposed solutions include lowering the income thresholds and increasing the penalties, but there is no need to worry about this, right? Well, we also have to consider the fact that Medicare premiums (along with any surcharges) are automatically deducted from any Social Security benefit. I guarantee you that, in the not-so-distant future, there will be more than a few angry retirees wondering just where their Social Security check went.
3. The Hold Harmless Act
Last but not least, this is a provision created by Medicare in 1987 which states that “…increases in the premium may not exceed the dollar amount of the Social Security cost-of-living adjustment.” However, this too was “fixed” by Congress in 2009, with a rule that specifies that those who earn over these “means-tested income limits” are not protected by the Hold Harmless Act.
As stated, while everyone is staring at Obamacare, one more year has passed with no attention being paid to the fact that your clients’ Social Security will be vanishing due to their Medicare premiums being determined by their income in retirement — coincidentally, that same income which you have so diligently labored to provide.
And the solution to all of this?
Roth accounts and life insurance.
That’s right. Because of Social Security and Medicare’s definition of income, which is: “your adjusted gross income plus any tax-exempt interest, or everything on lines 37 and 8b of the IRS form 1040”, practically everything in a traditional financial plan will be used against those who are enrolled in Medicare.
Your clients’ (and your) income in retirement will be determined by the amount of income in retirement. The more one makes, the more in taxes and health costs they will pay while also receiving less and less in Social Security.
The beauty of life insurance and Roth accounts is the simple fact that the income received from them is not included in the definition of income. Please keep in mind that, again, this income will be used to increase Medicare premiums which are deducted from Social Security benefits.