DANGER: Cliff Ahead
MEET IRMAA. You won’t like her. IRMAA is short for income-related monthly adjustment amount. It’s a premium surcharge levied on those covered by Medicare Part B and Part D—and who have income above certain thresholds.
In 2020, the standard premium for Part B, which covers outpatient care, is $144.60 a month. That’s what you pay if you file taxes as a single individual and your modified adjusted gross income is $87,000 or less, or if you’re married filing jointly with annual income of $174,000 and below. What if your income, including tax-free municipal bond interest, exceeds these levels? You may be subject to the IRMAA surcharge.
The Part B premium is set so that it pays for 25% of Medicare’s actual cost. The remaining 75% is effectively subsidized by the federal government’s general revenue. The IRMAA surcharge is designed to remove this subsidy for those able to pay—those whose income is above the $87,000 and $174,000 thresholds. The IRMAA surcharge only affects 5% of Medicare recipients, but—depending on what happens with the inflation adjustments to the IRMAA income brackets—this 5% could increase over time.
In 2020, there are five different IRMAA income tiers. The Part B surcharge starts at $57.80 per month, equal to $693.60 annually, and gets as high up as $347 per month, or $4,164 annually. Keep in mind that the IRMAA surcharge is per person, so couples pay double these amounts.
If your income bumps you into the next income tier, you trigger the new tier’s full surcharge. For instance, income that moves you into the second tier—which starts at $109,000, versus $87,000 for the first tier—will trigger the second tier’s higher rate, even if you exceed the threshold by just $1. This so-called cliff penalty means that $1 of extra income triggers an additional IRMAA surcharge of $86.80 a month or $1,041.60 a year. A married couple would be looking at double the amount—equal to $2,083.20 a year.
To avoid triggering the IRMAA cliff penalty with modest additional income, you need to understand IRMAA’s timing, as well as what counts and doesn’t count as income. Medicare gets your income information from the IRS and bases the surcharge on your income from two years prior. For instance, when you’re age 65, Medicare uses tax returns from when you were 63. If you had a “life changing” event—perhaps you stopped working—you can file Form SSA-44 to get Medicare to look at current income. There’s no cost to do so and it’s a good idea if income from two years earlier is substantially higher than your current income.
Keep in mind that you could be bumped into a higher IRMAA bracket by, say, required minimum distributions from retirement accounts, a capital gain from selling your home or extra taxable income resulting from a Roth conversion. Even if this happens, the hit may be temporary: Medicare looks at income on an annual basis, so a taxable home sale or a Roth conversion only affects one year and won’t trigger a permanent increase in your Medicare premiums.
Are there any ways to avoid the IRMAA tax cliff? To cover your living expenses in any given year, you could reduce the taxable income you need to generate by instead taking tax-free withdrawals from a health savings account or a Roth retirement account. Neither of these is considered income for IRMAA purposes. Alternatively, once you’re in your 70s and above, you might reduce your required annual taxable withdrawal from your retirement accounts by instead making a tax-free qualified charitable distribution.
An IRMAA surcharge is also imposed on Part D, which covers prescription drugs. The Part D surcharge is smaller than that for Part B, but it uses the same income brackets. You could avoid the Part D IRMAA surcharge by skipping Part D coverage or opting for a Medicare Advantage plan without drug coverage. But while that may save you from the Part D surcharge, it could end up costing you dearly, depending on your prescription drug needs.
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. His previous articles include Early and Often, Don’t Get an F and Late Fee.
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