Beware the Medicare Surcharge When Crafting Retirement Income Plans

Americans are used to hearing questions and debates about the funding status of Social Security, with the program’s trust funds projected to run out of assets at some point in the early or mid-2030s, but in the experience of Sharon Carson, a J.P. Morgan Asset Management retirement strategist, far less public attention is paid to the equally dire funding status of Medicare.

The situation may have started to change this week, however, with the announcement by President Joe Biden that his forthcoming federal budget will include a higher proposed payroll tax on Americans making over $400,000 per year. Writing in The New York Times, Biden says the tax hike is meant to address the funding issues of Social Security and Medicare, and he says the federal budget will also seek to grant the government new power to negotiate drug prices, with the same goal in mind.

As Carson recently told ThinkAdvisor, the Medicare funding shortfall is one of the reasons why recipients of Medicare insurance coverage can be assessed a monthly surcharge — known as the income-related monthly adjustment amount, or IRMAA — when their income eclipses certain levels.

Depending on an individual’s or couple’s level of income during retirement, the surcharges can be sizable and so they should be considered as part of the holistic effort to build retirement income plans for advisors’ clients.

Carson urges financial advisors to study up on Medicare surcharges. Echoing other retirement planning experts, Carson says there is tremendous opportunity for advisors to deliver value to their clients by helping them strategically coordinate such decisions as when to claim Social Security, how to efficiently draw income from tax-sheltered accounts, and how to make retiree medical coverage decisions that keep costs under control while ensuring the needed care will be accessible and affordable.

“You can be a bit of a hero by helping your clients coordinate all of these things, and having a good understanding of the Medicare surcharge issue is an important part of the effort,” Carson says.

The Basics of Medicare Surcharges

As Carson spells out, Medicare surcharges are organized in a set of five income bands, and the surcharges get progressively higher as a recipient’s income grows. The specific surcharge amount, however, is the same for all income levels with a given band.

When assessing whether to institute a surcharge, the Social Security Administration uses the most recent federal return supplied to it by the Internal Revenue Service.

“This is usually the tax return from two years prior,” Carson notes. “Therefore, if an individual has stopped working or has reduced income due to circumstances outside of their control, they may be eligible for a surcharge appeal and may need to contact their Social Security office.”

Stated simply, the modified adjusted gross income used for the purposes of calculating Medicare surcharges is adjusted gross income plus tax-exempt interest income. Under current law, the thresholds increase each year with inflation, except the top threshold, which was added in 2019. This top threshold is set to inflate annually starting in 2028.

As Carson explains, for those filing singly, the first surcharge income band kicks in at $97,001 and runs to $123,000. Income at this level implies a $78 additional monthly premium surcharge (per person) for Medicare Parts B and D in 2023. For couples, this first income band kicks in at $194,001 and runs all the way up to $246,000, and it implies the same $78 premium increase per person for Parts B and D.

The next income band for singles runs from $123,001 to $153,000, and this implies a monthly premium surcharge of $196. For couples, this second band runs between $246,001 and $306,000.

The third income band for singles runs from $153,001 to $183,000 and brings a $314 surcharge. For couples, this third band runs from $306,001 to $366,000.

The fourth band for singles runs from $183,001 to $499,999 and implies a $433 monthly added surcharge. For couples, this band runs from $366,001 to $749,999. The newly added fifth income tier kicks in at $500,000 for singles and $750,000 for couples, bringing a surcharge of $472.

“As you can see from these numbers, the surcharge issue often comes into play for singles and surviving spouses,” Carson says. “Couples in the middle class are less likely to be impacted, but higher earners can see surcharges kick in.”

Other Important Medicare Facts and Considerations

As Carson explains, the basic process of claiming Medicare first involves signing up for Medicare Parts A and B via Medicare.gov. Part A is the main inpatient hospital insurance plan, whereas Part B is insurance that covers doctor visits, tests and outpatient hospital visits.

Choosing a specific plan will require thinking about potential out-of-pocket expenses related to Parts A and B, Carson says, as well as drug coverage and coverage for vision, dental and hearing care.

Broadly speaking, there are two primary approaches to this step. The first option is to use the original Medicare approach that is accepted by all Medicare providers. This approach, Carson explains, will mean signing up for Medigap coverage that addresses out-of-pocket expenses related to Parts A and B.

The individual or couple will then choose a Part D plan for drug coverage. Vision, dental, hearing and other benefits aren’t generally covered, however, so the person or couple may consider buying a separate policy.

The other main approach is to use Medicare Advantage/Part C, which has attractive features but only within a more limited network of providers. With this approach, insurance for out-of-pocket expenses related to Parts A and B is not included, so individuals and couples must be prepared for variable costs. Drug coverage is usually included, however, as is coverage for vision, dental and hearing benefits.

“It is key for individuals and couples to check the details,” Carson says. “Not all plans will include all the same benefits, and crucially, Medicare does not pay for most long-term care costs. Custodial care for activities of daily living also are generally not covered.”

In some cases, Medicaid may pay for long-term care if an individual has few assets and low income.

(Image: Centers for Medicare & Medicaid Services)