People who think IRMAA is another hurricane may have a tax shock coming when they go on Medicare.
IRMAA is short for income-related monthly adjustment amount. It frequently surprises retirees because it is tacked on to standard Medicare premiums for people with incomes above certain cutoff points. Although it is aimed at higher-income retirees, “you don’t have to be rich to fall into the penalty box,” notes Denver financial planner Phil Lubinski.
This year, IRMAAs hit individuals with modified adjusted gross incomes of more than $91,000, and for couples, more than $182,000. Instead of paying the standard annual Medicare premium of $2,041.20, higher-income individuals are paying from $3,006 to $7,874.40. Couples can pay double that.
Each year, Medicare charges are reset based on the income that people reported two years earlier. Even retirees who never had a problem can be blindsided by an IRMAA after an unusually high-income year.
Ignorance isn’t bliss in such cases. People can often make income adjustments before year end to dodge an IRMAA threshold, such as selling losing investments to offset capital gains. Cutting income by as little as a penny can slice almost $1,000 off an individual’s annual Medicare premiums at the lowest levels, and thousands at higher levels.
Retirees should watch out for potential income spikes. Pulling a big chunk of money from an individual retirement account in a particular year to buy a car, or pay for a trip, or for a Roth conversion, can push them over the IRMAA threshold.
Planning to avoid IRMAA should start at age 60 and continue annually because each year’s tax return matters, says Newport Beach, Calif., certified public accountant Robert Klein. The amount of income that seniors earn at age 63 will determine their premium when they turn 65, the year many retirees begin Medicare.
When a person reaches age 72, avoiding IRMAA gets tougher because of required minimum distributions, or RMDs, from IRAs. Long before a person is 72, financial planners try to get clients to whittle down balances through Roth conversions so annual RMDs are less likely to push a person over an IRMAA threshold.
Any money moved from IRAs is taxed as income the year it is converted. But small conversions done over many years can restrain the tax hit in any single year, and once the money is tucked into a Roth, it will be immune from RMDs. Any money withdrawn is tax-free.
That can be doubly important to a widow or widower after a spouse has died. Consider a couple that is taking RMDs after age 72 and never worries about IRMAAs because income from pensions, Social Security, and other sources has stayed just below the $182,000 IRMAA threshold for couples. Then, a spouse dies. The survivor will be taxed as a single person and will pay IRMAA penalties if income exceeds $91,000.
The good news: People can file an SSA-44 form with the Social Security Administration to report a “life-changing event,” such as the death of a spouse, divorce, or stopping work. If approved, that will alleviate or reduce an IRMAA for a year.
One of the simplest ways to cut retirement income and avoid IRMAAs is to start giving to charity directly out of IRAs beginning at age 70½, says Greg Geisler, CPA and Indiana University clinical accounting professor. Those distributions directly to charity won’t count as income. At age 72, these direct contributions from IRAs can be counted as required minimum distributions without triggering taxes.
Timing matters, Geisler says. To count toward an RMD, the charitable contribution must be made before the annual IRA required withdrawal. If a person has already received an RMD for 2022, Geisler suggests waiting until January to make the charitable contribution and counting it toward the 2023 tax year.
Retirees often fail to realize that lifestyle choices may shove them into an IRMAA. One common blunder: a poorly timed house sale.
Klein points to a couple who decided to sell their longtime home this year. Both were 63, the year that determines their Medicare premiums at age 65. The couple sold it for $1.5 million and had a $600,000 taxable gain. That gain, along with $200,000 in other income, catapulted them into the top IRMAA bracket. They will probably pay about $9,500 in additional Medicare premiums as a result of the home sale.
It’s based on a one-year burst in income, so there may be no IRMAA after that year. Other housing decisions can end up setting off IRMAA charges year after year.
Financial planner Peter Murphy of Santa Fe, N.M., had clients who were taking large annual withdrawals from their IRA to pay their mortgage and getting hit with IRMAA charges.
Murphy suggested they sell off other investments to pay off the mortgage. The sale would trigger large IRMAAs, but it would be a one-year hit. “One large bad year is better than death by 1,000 cuts,” he says.
This year’s investment losses provide opportunities to avoid IRMAAs.
Taxable distributions from mutual funds can launch a person over an IRMAA threshold. Leawood, Kan., financial planner Mike Wren had a client with mutual fund holdings likely to create IRMAA problems for years to come. “Selling them would result in large gains, but holding them means a minefield each December because we never know what the distribution will look like,” says Wren.
The client sold off the funds this year, and avoided capital-gains taxes because he offset the gain by selling other investments and booking losses.
This article was originally published in Barron’s on December 15, 2022, and written by Gail MarksJarvis
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