Since 2007, the Medicare Modernization Act of 2003 has required high-income Medicare enrollees to pay an Income-Related Monthly Adjustment Amount surcharge, or IRMAA, on their Medicare Part B premiums. This lifts the premium from covering just 25% of costs up to as high as 80% of results, and increased Part B premiums by as much as 219% in 2017 alone.
This year, the IRMAA surcharges on Medicare premiums will apply more broadly, as changes under the Medicare Access and CHIP Reauthorization Act of 2015 reduce the top Modified-AGI (MAGI) threshold from $214,000/year down to $160,000 for individuals, or $320,000 for married couples. And taxpayers with MAGI as low as $133,500 or married couples at MAGI of $267,000/year will be forced into a higher IRMAA tier than before, resulting in a nearly $1,000/year increase in IRMAA surcharges.
Granted, IRMAA surcharges still only amount to a roughly 1% to 2% cost increase relative to the income the household must have to be subject to IRMAA in the first place. So while managing taxable income is important, it’s equally crucial not to let the tax tail entirely wag the dog (unless, perhaps, you’re very close to the next threshold!).
Nonetheless, the new IRMAA rules will make Medicare-related tax planning more popular than ever. For advisors seeking yet another way to demonstrate value to their clients, it pays to know the strategies available to them — and what makes the most sense this year and beyond.
Health insurance is expensive, especially for retirees, who tend to have more frequent health complications.
To help manage costs, in 1965 President Johnson signed into law the legislation that established Medicare as the health insurance foundation for senior citizens over the age of 65 — which was further supported by the creation of Medicaid for certain low-income individuals.
Under Medicare, the federal government pays for 100% of Part A insurance, generally understood as hospital care, and generates the revenue to cover those costs through the 2.9% Medicare component of the 15.3% FICA tax on employment income. In addition, the Federal government covers about 75% of the cost of Part B insurance, relating to other medical services and paid from general revenue, with the other 25% of the cost of Medicare Part B paid directly by Medicare enrollees in the form of a monthly Part B premium. Each year, the Part B premium is set by the Centers for Medicare and Medicaid Services (CMS).
Since 2006, under the Medicare Modernization Act, Medicare enrollees have access to, also pay a portion of, the Medicare Part D (i.e., prescription drug) coverage with ongoing monthly premiums as well.
For most individuals, Part B and Part D premiums are simply paid by being withheld from their monthly Social Security checks, though those who are delaying Social Security benefits but have already enrolled in Medicare must pay their premiums directly.
The Medicare Modernization Act of 2003, which introduced Medicare Part D prescription drug coverage for the first time, also shifted how Medicare Parts B and D are funded by requiring high-income Medicare enrollees to pay a higher-than-25% portion of their Medicare premiums, beginning in 2007.
Specifically, the rules require that Medicare enrollees whose MAGI exceeds $85,000 as an individual, or $170,000 as a married couple, must pay 35% of the total Part B premium — up from 25% — rising as high as 80% of the total Medicare Part B premium cost once income exceeds $214,000 of Modified AGI for individuals, or $428,000 for married couples.
Similarly, beginning in 2011 under the Affordable Care Act, higher-income individuals are now also required to pay a surcharge on their Medicare Part D prescription drug coverage. Unlike the Part B surcharge, which applies a surcharge to enrollee premiums to ensure it covers a target percentage of total cost, the Part D income-related surcharge is simply a flat dollar amount, starting at $13.30/month and rising as high as $76.20/month for those in the highest income tier.
Notably, these IRMAA surcharges are applied based on modified AGI, which in this case is simply the individual’s AGI plus any tax-exempt bond interest that must be added back to determine if the thresholds are reached. And each of the four surcharge tiers are so-called cliff thresholds, meaning even $1 of income past the threshold results in the entire higher surcharge amount being applied.
Because Medicare premiums are set for the coming year at the end of the current year — for instance, 2018 premiums were set by October 2017 — a household’s IRMAA tier for Medicare is determined by using prior-prior-year income instead. Thus, for 2018, the household’s Medicare Part B and Part D surcharges — or lack thereof — and the ultimate issuance of any applicable IRMAA Determination Notice will be based on the 2016 tax year (i.e., the prior-prior year), using the tax return data filed in 2017.
The annual MAGI thresholds for IRMAA Medicare premium surcharges are adjusted annually for inflation, although under the Affordable Care Act, the inflation adjustments to the MAGI thresholds were frozen in place from 2011 to 2019. As a result, the impact of inflation on household incomes itself will cause at least some people to creep into a higher IRMAA tier, although overall the IRMAA surcharges are still projected to impact fewer than 5% of Medicare enrollees.
Although they have been in place for barely a decade, Medicare IRMAA thresholds have already undergone several changes — from the additional IRMAA premium charges to Medicare Part D in 2011 to the freezing of the MAGI threshold inflation adjustments. And under Section 402 of the Medicare Access And CHIP Reauthorization Act of 2015, the IRMAA rules were changed again, substantially decreasing the MAGI threshold to reach the top fifth tier at which households must cover 80% of their Premium Part B premium costs — and pay the maximum $76.20/month Medicare Part D surcharge.
Specifically, the new rules shift the top fourth income tier of IRMAA down from $214,000/year for individuals, or $428,000 for married couples, to only $160,000/year for individuals, or $320,000 for married couples. In turn, what was previously the third tier shifts down to the upper end of the second tier, and the prior second tier is further compressed.
The end result is that it now takes far less income for a household to reach the top IRMAA tiers.
As an individual’s income moves from $85,000 to $160,000 of MAGI, the taxpayer moves through all four tiers, shifting Medicare Part B premiums up an additional $294.60/month, or $3,535.20/year — on top of adding another $74.80/month of Medicare Part D IRMAA surcharges — for a total of $369.40/month, or $4,432.80/year.
And a married couple will experience these surcharges twice — once as each member of the couple enrolls in Medicare — as household MAGI rises from $170,000 to $320,000/year. These amounts come in addition to the baseline Medicare Part B premium itself, $134/month in 2018, plus the cost of the household’s chosen Medicare Part D premium, if applicable.
For those who were previously in the second or third IRMAA tiers, the impact is even more substantial, as they will effectively be shifted up an entire tier, boosting the IRMAA surcharge from $133.90/month (in 2017) to $214.30/month (in 2018), or from $214.30/month (in 2017) to $294.60/month (in 2018). This amounts to a nearly $1,000/year increase in IRMAA surcharges.
It’s also notable that those who are subject to IRMAA Medicare surcharges are not eligible for the so-called Hold Harmless rules that cap the annual increase in Medicare premiums at the dollar amount increase of Social Security’s COLA increase — which, as occurred in 2016, can cause Medicare Part B premiums to spike for those impacted by IRMAA.
However, for better or worse, given that the first IRMAA surcharge tier — the threshold where the first surcharge applies — is still the same $85,000 for individuals and $170,000 for married couples, the new IRMAA thresholds won’t impact high-income Medicare recipients any more now than they have in the past.
While many higher-income individuals will find themselves perpetually subject to IRMAA based on ongoing income that exceeds the MAGI thresholds, others may find that IRMAA impacts them only in occasional years where the first — or higher — IRMAA tiers are reached.
Accordingly, it’s important to recognize that even if a household has been subject to IRMAA in the past, it will not automatically be subject to the IRMAA surcharges in the future. Instead, the determination is made based on the individual’s reported income each year. The only caveat is that, due to the nature of the prior-prior-year income calculation, a household could have a reduction in income in the current year and still be subject to IRMAA due to higher income in prior years.
For instance, a married couple that had higher income in 2016 and 2017, due to a series of substantial Roth conversions in retirement that put their household income (MAGI) over $170,000, would be subject to IRMAA surcharges on their Medicare Part B and Part D premiums in 2018 (and 2019). This would happen despite their income being well below the specified threshold in 2018, when they’re no longer doing Roth conversions.
Still, because the 2018 premiums and surcharges were calculated based on the couple’s 2016 income, IRMAA will apply. Granted, the couple will benefit from lower income in 2018 — which eventually shields them from IRMAA — but the lower Medicare Part B and Part D premiums, without IRMAA surcharges, won’t apply until 2020, when income from the 2018 tax year is used.
On the other hand, sometimes a household’s income declines due to “life-changing” circumstances beyond its immediate control, such that using prior-prior-year income is no longer an accurate reflection of the household’s current financial status. In such situations, those impacted by IRMAA may submit Form SSA-44 — Medicare Income-Related Monthly Adjustment Amount Life-Changing Event — to request a surcharge reduction.
To have IRMAA surcharges reduced, the life-changing event must specifically be one of those listed on Form SSA-44, which includes:
- Widowing/death of a spouse
- Work stoppage (i.e., retired or laid off)
- Work reduction (i.e., material reduction in work hours)
- Loss of income-producing property due to a disaster or similar circumstance
- Loss of pension income (e.g., due to a pension default)
- Income for the year stemming from a settlement with an employer for the employer’s bankruptcy or reorganization
Newly minted retirees over age 65 who start Medicare immediately after retirement will usually need to file Form SSA-44 to report their work stoppage (i.e., retirement) and avoid having their pre-retirement wages treated as part of their MAGI when determining IRMAA surcharges in the first full year of retirement.
Fortunately, in subsequent years this is typically a moot point, as the post-retirement years with lower income often reduce MAGI below the first IRMAA threshold. Nonetheless, in the initial year or two of retirement, this can produce a multi-thousand-dollar savings on Medicare premiums for a married couple.
For those who have experienced a life-changing event that does not fit the specific list of choices on Form SSA-44, it’s also possible to file a formal appeal on Form SSA-561-U2. Officially dubbed a “Request for Reconsideration,” Form SSA-561-U2 is used to appeal a number of Social Security retirement or disability scenarios — including the application of Medicare IRMAA surcharges, which are technically determined by the SSA.
It’s important to recognize though, that mere substantial changes in portfolio and investment income — including various types of retirement withdrawals — are not treated as life-changing events eligible for an IRMAA surcharge exception.
Thus, a household that has a single or even multi-year big income event, from liquidating substantial portfolio capital gains to selling a primary residence — where the value was over and above the up-to-$500,000 capital gains exclusion under IRC Section 121 — taking sizable IRA withdrawals or engaging in substantial partial Roth conversions will have to pay IRMAA surcharges on Medicare premiums associated with that high income year. Though again, if the income event only lasts for a year or two, so too does the IRMAA Medicare premium surcharge.
While it’s fortunate that Medicare enrollees who experience income-reducing life-changing events may be able to file Form SSA-44 to avoid IRMAA surcharges on Medicare premiums, it’s preferable to simply manage income to stay below those thresholds.
At the same time though, it’s crucial to recognize that — relative to the income levels it takes to hit IRMAA thresholds in the first place — IRMAA is really just the equivalent of a modest income surtax.
The optimal IRMAA planning strategies will typically manage those clients already close to the threshold, where a relatively small shift in the timing of recognizing capital gains or harvesting capital losses can get a household below it. This makes it essential for advisors to know which clients have household incomes approaching an IRMAA threshold — as again, a mere $1 over the line can instantly result in a $600 to $1,000 Medicare premium surcharge.
Advisors must also be aware of clients whose income levels exceed the IRMAA threshold, but may legitimately be able to claim a life-changing-event exception via Form SSA-44 — especially recent retirees, whose retirement itself will render them eligible.
Nonetheless, with the 2018 changes to the IRMAA thresholds, the upper IRMAA tiers now impact retirees more quickly as their income rises, which in turn increases the value of IRMAA planning. That in turn increases the value of the advisor who has good planning strategies.
So what do you think? Do you plan around IRMAA surcharges for your clients on Medicare? In what other “surprising” situations have you seen IRMAA have an impact? Please share your thoughts in the comments below.