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  • Writer's pictureJames McGlynn CFA, RICP

IRMAA boosted by Capital Gains

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.

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