Getting ready for retirement can be an overwhelming task for many people. Just when you think you've got everything figured out, a random issue always seems to pop-up. Income-Related Monthly Adjustment Amount (IRMAA) is one of these common issues pre-retirees run into. However, its usually a pain point they experience after the fact. Meaning that by the time they understand what's going on, it's to late to fix. As you'll learn later, IRMAA can be an expensive problem to have. That is why in this blog we are going to cover the basics of IRMAA and how it can impact your retirement planning in 2022. So you can feel confident about taking that next step toward a successful retirement, without the concern of any unintended added expense.
What is IRMAA and how does it work?
When does IRMAA apply? How can you prepare your income accordingly?
Planning Opportunities while considering IRMAA pitfalls.
Appealing IRMAA premium increases.
What Is IRMAA
To start, let's identify what exactly IRMAA is. The Social Security Program Operations Manual System describes IRMAA as a set of statutory percentage-based tables used to adjust Medicare Part B and Part D prescription drug coverage premiums. The higher your modified adjusted gross income, the higher the IRMAA. Basically, it's a way for Medicare to take in more premium dollars from the individuals who have a higher income.
The table used to determine if you will owe more in premium or not is based on a number of different factors. These include your filing status (Single, Head of Household, Married Filing Jointly, Etc.), sliding scale, and premium year. For example, let's say you are a married filing jointly tax filer and your Modified Adjust Gross Income (MAGI) is $180,000. This would result in no additional IRMAA premiums for Medicare B & D. In 2022, the MAGI cut-off line is $182,000 for MFJ filers. Any income below that amount would result in that individual paying the normal premium of $170.10/month in 2022 for Medicare Part B.
However, let's assume that same married filing jointly couple has an income of $185,000. Now they will have breached that first threshold in the IRMAA sliding scale which would increase the individual premium from $170.10 to 238.10/month. An annual increase in premium of $816. It would also increase the individuals Part D premiums by $144/year (+ plan premium). Which means that in this example, an additional $5,000 of income resulted in an increase of $960 in Medicare premiums in the year. This premium increase becomes greater, the higher your income goes. The table below outlines each threshold for a Married Filing Jointly tax filer.
|Part B Premium Adjustment per Month
|Part D Premium Adjustment per Month
|$0 - $182,000
|$182,000 - $228,000
|$228,000 - $284,000
|$284,000 - $340,000
|$340,000 - $750,000
|$750,000 and above
When Does IRMAA Apply?
So as of now, we know that the increased IRMAA premiums apply to those who have a higher income in a year. Many of you may be thinking that when you get to retirement, you'll have far less taxable income than what you did while working. Although this may beneficial for you further into retirement, it may not provide the relief you expect during your first few years of retirement. That is because the additional IRMAA premium surcharge is not calculated based on current or previous year income.
IRMAA is determined by income from your income tax returns two years prior. This means that if you are trying to determine what your 2022 Medicare premiums will be, you will need to look at your 2020 income tax returns. This amount is recalculated annually for each year thereafter. So this is where most people experience the pain of unexpected higher premiums. Let's assume that in the year 2020, you experienced a large windfall event. Due to that large windfall event, your 2020 tax return showed a much higher income than normal. Let's say that your 2020 income as a married filing jointly filer was $350,000.
2021 income and beyond will be much less than that. Especially when you start retirement in 2022. Even if you only plan to live on $90,000/year in retirement, your Medicare B and D premiums will be $7,380 due to that windfall event in 2020. That is $5,340 more than what it would have been if premiums were based on current income. This means that a much larger portion of your retirement cashflow each month will be going toward paying those increased premiums.
This becomes even a bigger pain if you experience greater pay increases or bonuses as you approach retirement. Especially if that increased pay puts you right over the edge of any of those IRMAA income thresholds. So it's definitely something to keep track of and work around if you have the ability to do so.
Planning Opportunities With IRMAA
Now that we understand how it works and what factors contribute to it's increased premium, what can we do about it? Well the most obvious answer is to make sure your income doesn't cross the "next" IRMAA income threshold. By not allowing your income to grow past the next IRMAA threshold, will ensure that an increase in premium won't happen two years from now if you find yourself taking Medicare benefits. However, using this strategy may prevent you from experiencing the other benefits you may have available to you by actually increasing your income.
Roth IRA Conversions
Roth IRA conversions are beneficial when you convert money from your traditional IRA or 401(k) to a Roth IRA. Any of this money that is converted is treated and taxed as ordinary income in the year. Which means that converting money in a given year will increase your annual income for IRMAA calculation purposes. But does an increased IRMAA premium worth the benefit of a Roth conversion. Let's find out.
Ex: Let's assume Tom and Mary file a MFJ tax return. Let's assume that they are both two years away from retirement. Tom and Mary currently earn an income of $175,000. With deductions, their taxable income is $148,500. This taxable income amount puts them comfortable in the 22% federal marginal tax bracket. Let's also assume that they plan to reduce their taxable income down to $105,000 once in retirement. The $105,000 of retirement income would also put them into the marginal tax bracket of 22%, two years from now in retirement.
Tom and Mary are trying to determine the costs and benefits of doing a Roth conversion of their IRAs. They currently have the majority of their retirement savings in a traditional IRAs. About $2,000,000 worth. They understand this puts them at an enhanced tax risk in retirement. If tax rates go up in retirement, it means the IRS will have ownership of a greater percentage of their $2,000,000 retirement nest egg. Because of this, Roth conversions may be beneficial to diversify their tax risk before retirement.
Tom and Mary are thinking about doing a Roth conversion of $22,550. This would take their taxable income up to $171,050, which is the top of the 22% marginal tax bracket. Their thinking is that if tax rates revert back to pre-2018 levels, their $85,000 of taxable income in retirement would result in a top marginal tax bracket of 25%. This means that converting the $22,550 of traditional money today would result in a guaranteed tax of 22% while potentially avoiding a higher rate of 25% in the future IF current rates revert back to what they were in 2017.
If tax rates revert back to 2017 levels, they would save about 3% in taxes by making the Roth conversion today. This would result in a total savings of $676.50. If they do this two consecutive years before retirement, it's a potential tax savings of $1,353. However, the additional increased income due to that Roth conversion would put them above the first IRMAA threshold. Meaning that for the first two years of retirement, they would have to pay an additional $960 in premiums each year. That Medicare premium increase would outweigh the potential tax savings benefits of the Roth conversion. It would be even a bigger loss for Tom and Mary if they do the Roth conversion and rates don't go up in the future. That means they would save nothing in taxes by doing the conversion while increasing their future Medicare Part B and D premiums.
There is a lot of information to consider in that scenario. And each individual and family situation will be different. But it just outlines that even though you could be making a beneficial money move before retirement (like taking advantage of Roth conversions), it may end out doing more harm than good due to IRMAA. It just solidifies the fact that you have to be very careful with your money decisions when leading up to retirement.
Appealing IRMAA Increase Premiums
What happens if you make a mistake and you inadvertently increase your Medicare Part B and D premiums due to IRMAA. You mistakenly added additional income on your tax return, not thinking about how it will impact your Medicare premiums 2 years down the road. And now you just received a notice in the mail from Social Security letting you know you will owe more in premium. The good news is that there is opportunity for IRMAA relief (kind of).
You have the right to appeal. Appealing an IRMAA decision is also referred to as requesting a reconsideration. This is a request you would file with the Social Security Administration (SSA). However, the probability of winning this appeal is small. It usually takes circumstances that are unusual and/or extraordinary for the SSA to readjust your premium levels. Most likely, a harmless mistake made inadvertently would not be enough for them to reverse the IRMAA increase. So it's always better to be proactive with your income planning rather than trying to proceed with an appeal after the fact.
It's very important to start preparing for retirement multiple years out. There are a lot of mistakes that could be made that might not be realized or felt until you actually get into retirement. Avoiding certain income-boosting changes to your annual income is something you're going to want to be aware of. But it's also important to consider the benefits of increasing income before retirement versus the pitfall of the increased Medicare premiums you'll face a few years later. And it's not just pre-retirees that should be continuously planning for IRMAA. Retirees who are already in retirement need to keep this front of mind as well. Especially once they make it to Required Minimum Distribution age.
Finally, I think it's important to note that IRMAA does go away. Just because you experience one year of increased income, doesn't mean your Medicare B & D premiums will be higher forever. Those premiums are only increased within the year that is 2 years from that elevated income year. So an income mistake made before retirement won't end up costing you throughout the remainder of your retirement years.