THIS IS THE LAST year that my income won’t affect my Medicare premiums.
At issue is IRMAA, or income-related monthly adjustment amount, which is the premium surcharge for Medicare Part B and Part D if you exceed certain income thresholds. The surcharge is based on your modified adjustment gross income from two years earlier. Like almost all retirees, I’ll begin Medicare at age 65. That means IRMAA will be based on my income for the tax year when I reach age 63, which will be 2022.
I currently have a pension and an income annuity that, taken together, put me below the IRMAA income threshold. But if I do Roth conversions or realize capital gains, I might exceed the IRMAA thresholds and be subject to the surcharge. I’ve been doing Roth conversions for the past six years but will stop those this year.
What about capital gains? For single individuals, long-term capital gains are taxed at 0% if your 2021 taxable income is below $40,000 ($80,000 if married), 15% if your income is $40,001 to $441,450 ($80,001 to $496,600 if married) and 20% if your income is above $441,450 ($496,600 if married).
IRMAA could potentially add to that cost since capital gains are included in calculating your modified adjusted gross income. On top of that, IRMAA is a so-called cliff penalty, meaning that—if you breach an IRMAA income threshold by $1—you have to pay the full surcharge for that income bracket. You can view the IRMAA income thresholds here. The same thresholds apply for both Part B and Part D.
My goal: Figure out whether taking capital gains this year at a 15% rate was better than delaying until 2022, when I could potentially trigger IRMAA. I looked at the first two IRMAA cliffs, which for single individuals start at $88,000 and $111,000 in modified adjusted gross income.
What I found was alarming.
If I realized a capital gain and exceeded the $88,000 threshold by $1,000, my capital gains tax on that $1,000 would be $150, but my total Part B and Part D IRMAA surcharges would be $860.40, for a combined total tax of $1,010.40. In other words, the combined tax rate on that $1,000 would be 101%, the punishing result of the way Medicare’s cliff penalties work.
What if I exceeded the $88,000 threshold by $5,000? My capital gains tax would be $750, but my Part B and Part D IRMAA surcharges would remain at $860.40, for a combined $1,610.40. That’s equal to a 32% tax rate on my $5,000 in capital gains. At $10,000 over the threshold, the tax rate is 23.6% and, at $23,000 over, the tax rate is 18.7%.
For the first two IRMAA brackets, it’s clear that—if I’m going to exceed the IRMAA threshold and trigger the cliff penalty—I might as well make the most of a bad situation and try to bump up close to the next threshold, so I end up paying a lower overall tax rate on my capital gain. Since the second bracket starts at $111,000, I should come as close to that threshold as possible, which would lower the combined IRMAA-plus-capital-gains tax rate to 18.7%. If I was to exceed $111,000, I should get as close as possible to $138,000, which would result in a combined tax rate of 19.8%.
The bottom line: If I wait until next year to realize capital gains at 15%, IRMAA could turn that 15% rate into something closer to 20%—and that assumes I manage my income properly, and don’t accidentally slip into the next IRMAA bracket and trigger the next cliff penalty. Result? I’m taking more capital gains this year, knowing the cost will be just the standard 15% long-term capital gains rate.
James McGlynn, CFA, RICP, is chief executive of Next Quarter Century LLC in Fort Worth, Texas, a firm focused on helping clients make smarter decisions about long-term-care insurance, Social Security and other retirement planning issues. He was a mutual fund manager for 30 years. James is the author of Retirement Planning Tips for Baby Boomers. Check out his earlier articles.
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Thanks for the article – its very well written and helpful.
It’s articles like these that remind me of one of the best parts of my former jobs…sitting at the lunch table at work with my very smart colleagues.
What is MAGI? I know, read the article – HOWEVER:
This may sound silly, but after parsing this and a few other iems on the web includng IRS pubs I still don’t know how to calculate MAGI. Why?
I suspect the authors may be “cursed by knowledge” of what seems the first and most essential step: Is the MAGI figure obtained before or after subtracting the standard or itemized deduction(s)?
Right now I only know my MAGI give or take $12,550 (the standard deduction).
I have no problem with higher Medicare taxes as my income rises, but the current process has two big problems as I see it. 1) the ‘gotcha’ of the steps in applying the additional costs; one dollar over and you go in the hole big time. 2) In any tax year, NO ONE knows what the exact dollar MAGI points for those steps will be two years in the future–that’s the way the process works; a two year look back for MAGIs that are applied to steps that that are specified after the two years ago tax year ended.
The normal income tax process is much fairer, applying higher rates progressively with no step functions.
Good article but unfortunately it is difficult for most of us to estimate our income and avoid triggering this Medicare tax. I am a CPA and I find it almost impossible because of my spouse’s income, dividends and interest income. It should not be so difficult.
Nice article, and good food for thought. If retired prior to age 63 and holding significant taxable long term capital gains, it might be beneficial to realize as much as possible at 15% in those years with low income and before one needs to be wary of IRMAA. I’ve written before about realizing LTCG up to the 0% rate, but can see potential benefit of realizing much more in these years, especially if proceeds are reinvested so as to achieve a more tax efficient portfolio overall.
Michael the 0% not an option for me but yes taking outsize gains at 15% -especially after the market gains is more palatable than triggering IRMAA and paying at higher rates.Can redeploy some into HSA and cash value and pay taxes from Roth conversions.
You can run but you can’t hide. Deferring Roth conversions can lead to higher RMDs that will also drive up your IRMAA impacted premiums.
You’re exactly right, and that’s a great argument, IMO, for arranging Roth conversions and other sources of income so that you reach the top of the 24% tax bracket (before the big jump to 32%) and go ahead and take the big IRMAA hit. It’s only for one year. As always, be mindful of which cliff you wish to avoid.
Great point Steve. Need to do one’s best at looking out into the future, not just the next year. Thus I also do Roth conversions up to the 24% max rate(or closest IRMAA cliff) as this rate at that income level is the best in my adult lifetime and I’m betting that marginal rates go back up in the future – that may not happen, but my personal bet on likelihoods. I also use QCDs now that I hit 70.5 for chartiable contributions to also help manage my MAGI(IRMAA trigger) and taxable income rates.
I have been doing Roth conversions for 6 years to reduce my RMD’s.
Whenever considering taking larger capital gains distributions, or doing larger Roth conversions, I would strongly suggest giving serious consideration to some good tax prep software, and run some numbers beforehand. This can help prevent some unexpected and nasty surprises, as well as uncovering potential opportunities that one couldn’t see at a distance. You’ll want to include state taxes as well, especially for Roth conversions, to see if the math makes sense in your situation. And of course, if your health-care premiums are income-based, it’s all the more important to make sure you’re sure you want to take the gains or do the conversions, since there’s no un-doing them any more. Good luck!
I am lucky twice. Texas has no state income taxes and I have retiree medical insurance from my last employer- for now! Many moving parts involved.
It’s notable that the 22% and 24% brackets are quite close, and it’s quite a jump to the next bracket at 32%. In trying to make meaningful Roth conversions, I focus first on staying in the 24% bracket, then decide which IRMAA cliff I want to avoid, and stay a few thousand dollars below that for safety’s sake.
If you are well-off, it’s practically impossible to avoid taxes, including IRMAA. That’s how the system was designed. Single retirees with incomes of $100K, $150K, $250K will pay year after year. At least they don’t have to worry about LTC insurance!
I have a hybrid LTC policy so hopefully have that covered as well.
Nice article Jim. You do great job of illustrating the intersection of various parts of the tax code. Understanding these intersections helps people make smart decisions as they try to generate retirement income.
Thanks Rick. I had written about the “Cliff” before but seeing how it is adds to the capital gains rate was a surprise to me.
I always find the IRMAA discussion interesting. It pops up on several retirement FB groups I follow too. Usually it’s about the strategies, including keeping income low, to avoid IRMAA altogether or at least getting into the next higher bracket.
I doubt anyone, including me, wants to pay more in taxes or insurance premiums. My IRMAA will drop a bracket in 2022 simply because I did not take an RMD in 2020, but it goes right back up in 2023. I would sure like to pay less.
But the thing is in 2022 the point at which IRMAA kicks in is projected to be $91,000 for a single person. That’s considerably above the median household income for the 65+ age group.
If a retired couple has an income of over $180,000 isn’t “fair share” a factor in all this? On the other hand, regardless of income level we all want to pay the lowest in taxes possible.
My wife and I will likely hit the IRMAA threshold the first year she has an RMD (in about 10 years currently)-all due to various retirement accounts and only retirement accounts (delayed SS, small pensions and IRAs), even with doing a few partial Roth conversions. Sure we had relatively high incomes later in our careers but also Roth came along later and our income precluded it. I had many years of lower income before Roth along that I would have gladly put money in Roth 401(s)s but they weren’t available. While I don’t disagree high income folks can pay more and it won’t be a huge hit for us, I do struggle with the fairness aspect as we will be paying premiums on retirement account income only-is that really fair? Ill pay it but I reserve my right to be a grumpy old man about it.
Yes Richard at least IRMAA is being indexed for inflation now. Admittedly IRMAA is a “first world problem” but as you know many think paying a tax of 15% is painful enough without kicking in the extra IRMAA surcharge.
How do you arrive at IRMAA charges of $860,40. Not even the highest income level comes close to that?
That’s the annual number. For those in the lowest IRMAA bracket, it’s $59.40 per month extra for Part B and $12.30 for Part D. Add those together and multiply by 12 and — bingo! — you have $860.40.
Ah, I think in monthly terms on premiums.