How your income effects your Part B Medicare premiums
At Dashboard, we have a borderline unhealthy obsession with Roth IRAs – we think they are “wicked awesome”. We regularly challenge clients to complete Roth conversions when it makes sense in order to get more of their dollars into a tax-free environment. But for those age 63 and up, you may have to pay more than just the tax owed on your Roth Conversion…
Age 65 is the Medicare milestone – the age at which you are first eligible to enroll in Medicare Part A (hospital insurance) and Part B (medical insurance). Most Americans do not pay a monthly premium for their Part A coverage, as this is typically “paid-in” via Medicare taxes during working years. There is a separate monthly premium, however, for Medicare Part B coverage. Part B premiums have a minimum “standard premium” floor plus an Income Related Monthly Adjustment Amount (IRMAA) based on modified adjusted gross income (MAGI) from 2 years ago. The monthly premium amounts as well as the MAGI thresholds are often adjusted annually.
The fact that Part B premiums are calculated based on a rolling 2-year “look-back” of your MAGI can be relevant when planning for Roth conversions, as the process of converting is a taxable event that increases your income dollar for dollar. Beginning at age 63, be aware that any significant Roth conversions may bump you up into a higher Medicare Part B “premium bracket”, which will cost you the tax payment on the conversion AND the difference in cost between monthly premiums at the higher rate (but not for 2 years).
Roth conversions after age 63 will cost the tax payment on the conversion plus the difference in cost between monthly Medicare Part B premiums at the higher rate.
As an example, a married couple over age 65 with ordinary income of $75,000 would pay the standard monthly premium of $144.60 per person ($3,470.40 annually) for Medicare Part B in 2020. If this couple chose to complete a significant Roth conversion(s) – let’s say $250,000 to get them up to about the top of the 24% federal income tax bracket – they would be immediately responsible for a tax payment on the conversion of approximately $57,500. Additionally, in 2 years their Medicare Part B premiums will increase based on the higher income from the conversion. If we assume costs and thresholds for calculating Part B premiums remain constant at 2020 levels, their monthly premium for 2022 would be $376.00 per person ($9,024.00 annually) – an increase of $5,553.60 for the year. Keep in mind, this higher premium rate would only be in effect, in this example, for the year 2022, and would drop back down likely to the standard premium rate in 2023 assuming the same ordinary income of $75,000. The point is the $250,000 Roth conversion in 2020 cost this couple, in our example, an additional $5,553.60 in 2022 that they may not have considered when completing the conversion.
We recommend having a clear understanding of what your MAGI will be each year in retirement – particularly if you are completing Roth conversions – so that we can be mindful of these additional costs. It may be worthwhile to keep yourself in a lower “premium bracket” as these premium costs are not graduated – as soon as you cross the threshold you are now subject to the higher premium rate. This is just one of the many moving parts that can either facilitate or hinder your financial success…let’s aim for the former and work to keep you on the path to financial independence!
Converting a traditional IRA into a Roth IRA has tax implications. Additionally, each converted amount may be subject to its own five-year holding period. Investors should consult a tax advisor before deciding to do a conversion.