Most new retirees look forward to the day when they’ll finally qualify for Medicare coverage.  After all, health insurance costs are one of the most substantial expenses many pre-retirees have to grapple with. Unfortunately, clients quickly learn that Medicare isn’t quite as “free” as they expected — after they receive a notice telling them how much will be deducted from their monthly Social Security checks.

Premium payments for Medicare Part B are based upon the Medicare recipient’s income, so most retirees assume they’re in the clear once they stop working. Unfortunately, premium levels are calculated using a two-year lookback period — and clients are often surprised at the amounts included in the calculation. Clients should be advised that they do have options that can help them avoid the post-retirement Medicare premium sticker shock.

Understanding the 2020 Changes to the Medicare IRMAA Rules

Medicare income-based surcharges, or the income-related monthly adjustment amount (IRMAA), are determined based on a sliding scale that uses the Medicare recipient’s modified adjusted gross income (MAGI). Clients in higher income tiers have higher Medicare premium costs.

Unfortunately, the system bases those IRMAA surcharges on the client’s income from two years ago. That means clients who retired in 2020 will find that their premium liability is based on their income levels while fully employed in 2018.

Income Tiers

Six tiers of income levels currently exist to determine premium liability for higher-income clients. Beginning in 2018, the rules changed so that starting in 2020, more moderate-income clients now find themselves in the tiers that impose the highest surcharges.

Under the rules, single clients who fall into the “first tier” with MAGI under $85,000 in 2019 ($170,000 for joint returns) were not subject to the income-based surcharges and paid only $135.50 for their monthly Medicare Part B premium.

Conversely, single clients with MAGI of between $160,001 and $500,000 fell into the second highest (“fifth tier”) income bracket, and clients with MAGI that exceeded $500,000 (single) or $750,000 (joint returns) paid the highest surcharges in the sixth tier.

Importantly, the IRMAA can result in additional Medicare premium costs that can reach $460.50 per person every month.

Beginning in 2020, those income brackets have been indexed for inflation for the first time in nearly a decade, meaning that the first-tier income level increased to $86,000. However, most clients in the highest income brackets will not benefit from indexing until 2028, so these taxpayers will remain in the highest tier despite indexing at lower levels.

What Can Clients Do About IRMAA Surcharges?

Clients who anticipate their income levels to remain relatively high even during retirement should look into strategies to reduce MAGI before they become eligible for Medicare. Clients should, of course, take advantage of tax-preferred retirement accounts to reduce MAGI — contributing to a 401(k) can reduce AGI by at least $19,500 in 2020 and 2021 (clients age 50 and older can contribute an additional $6,500 in pretax funds to these accounts).

HSAs and Roth IRAs can also provide sources of tax-free income during retirement. Clients who have reached age 70½ can reduce MAGI by up to $100,000 per year by using their IRA required minimum distribution (RMD) to contribute to charity in a qualified charitable distribution (QCD).

For other clients, the solution might be to simply inform Medicare that their income has dropped substantially for the year in question. Clients can do this by submitting Form SSA-44, “Medicare Income-Related Monthly Adjustment Amount Life-Changing Event” to their Social Security office. Both “work reduction” and “work stoppage” qualify as life-changing events.

That one simple step can save the client thousands of dollars in Medicare premiums. However, it’s important for clients to pay close attention to their taxable income in all future years to avoid another premium spike. That can require careful pre-retirement planning to ensure the client has access to tax-free sources of income, like a Roth account or cash balance life insurance policy with sufficient cash buildup.

Conclusion

Unanticipated expenses can have a dramatic impact on clients once they hit retirement.  Medicare and health care costs will likely continue to be one of the largest expenses for most clients during retirement — so it’s critical to plan now to avoid unpleasant surprises down the road.

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