Want to Enhance Your Retirement Security? Don't Invite IRMAA!

Want to Enhance Your Retirement Security? Don't Invite IRMAA!

IRMAA is not your friend in retirement. She'll do nothing but cost you money. You may be able to slay her with careful planning - and a Health Savings Account - before you retire.

This is the last installment in our four-part series on the lesser-known tax benefits that a Health Savings Account delivers (beyond pre-tax or tax-deductible contributions tax-deferred/tax-free principal growth, and tax-free withdrawals for qualified expenses). We previously noted that federal payroll (FICA) taxes aren't applied to pre-tax payroll deductions, Health Savings Account balances aren't subject to Required Minimum Distributions as tax-deferred retirement balances are, and withdrawals for qualified expenses aren't included in the income calculation that determines how much of your Social Security benefit is included in your federal taxable income.

In my conversations with contemporaries (e.g., those approaching the age of Medicare eligibility faster than we care to acknowledge), I am surprised by the lack of knowledge about how Medicare works. Too many Americans approaching retirement don't understand that Medicare is not free (premiums for Part B and Part D), that services aren't covered in full (deductibles apply, and outpatient care is subject to unlimited 20% coinsurance), and that other take-for-granted coverage like dental and vision isn't included in Medicare.

This ignorance is appropriate content for a book. Let's look at one aspect of this knowledge gap: Medicare premiums.

Medicare Coverage and Premiums

The Medicare program consists of three distinct Parts that cover different services. Each has separate premiums and separate cost-sharing that aren't aggregated into a single out-of-pocket limit. And the penalties for delayed enrollment vary among the Parts. A quick description of each:

Part A: Part A covers inpatient care, home health care, and hospice services. You pay a $1,556 deductible for each unique inpatient visit and are limited to a certain number of days per calendar year, with a small allotment of additional days per lifetime.

If you or your spouse worked at least 40 quarters (10 years) of minimal earnings per quarter, you have prepaid your premium for Part A coverage with a percentage of your federal payroll taxes. You won't pay anything additional when you enroll. But beware - that funding source won't cover all claims beginning in about 2028, so someone - you as an enrollee, all Americans through subsidies from the treasury, future generations through government borrowing - will have to pay the balance.

Part B: You pay a monthly premium of at least (keep the phrase at least in mind - we'll get back to it in a moment) $170.10 for this coverage for outpatient services. That figure represents about 25% of the average claims per enrollee under Part B. The balance of the premium is paid from general revenues.

You pay the first $233 of covered services, then 20% coinsurance thereafter. There is no cap on the coinsurance, so you could owe $5,000, $50,000 or more than $100,000 if you undergo an expensive course of treatment outside the hospital. Many Medicare enrollees purchase a private Medicare supplement plan to limit their coinsurance exposure and provide some other financial benefits.

Part D: This is a program offered by private insurers regulated by Medicare officials. The plans charge a premium, which averages about $35 monthly in 2022. That premium covers about one-quarter of the cost as well. The general treasury pays the remainder of all claims. The drugs covered vary by plan.

IRMAA and Part B Premium

Enter IRMAA, or the Income-Related Monthly Adjustment Amount. As noted above, enrollees pay a premium for Part B and Part D coverage. And that premium is heavily subsidized by all taxpayers. The programs are designed so that higher-income enrollees receive a lower subsidy as their incomes increase.

For example, the standard premiums for both Parts apply to an individual tax filer with a modified adjusted gross income (MAGI) below $91,000 and joint filers below $182,000. But exceed those thresholds and premiums increase to $238.10 for Part B and an additional $12.40 (beyond the standard premium, which varies by plan) for Part D. At the next tier (above $142,000 for individual and $284,000 for joint filers), the premiums increase to $340.20 for Part B and premium+$32.10 for Part D.

Few people would argue that it's unfair to reduce taxpayer subsidies for premiums to cover higher-income seniors. But if you're an individual filer and closing in on the $91,000 income limit before subsidies apply, you may want every tool available to keep your income below that figure. After all, you must pay all the taxes assessed, but no one requires you to leave a tip to the IRS.

Exceed it by $1 and your monthly premiums increase by $68.00 for Part B and $12.40 for Part D. That's a $965 premium increase if you exceed the income ceiling by as little as a penny. That's a bad negative ROI.

How a Health Savings Account Can Defeat IRMAA

A Health Savings Account can help keep you in a lower tier for IRMAA surcharges if you're close to hitting another level. That's because distributions from a Health Savings Account for qualified expenses are treated as reimbursements, not income. In other words, paying medical bills with withdrawals doesn't affect your modified adjusted gross income. In contrast, the same withdrawal from a tax-deferred Individual Retirement Arrangement or 401(k) plan is included in your MAGI.

Example: You're an individual filer. In December, your income is $90,000. But you have $3,000 in unpaid medical bills. If you withdraw t$3,000 from your Health Savings Account to pay those expenses, your MAGI remains at $90.000, or just below the threshold for a surcharge of $68 monthly on Part B and $12.40 on Part D premiums. In contrast, if you withdraw that amount from your tax-deferred IRA, your MAGI increases to $93,000 and you pay the additional $965 in premiums.

This example is slightly misleading. The surcharge is applied to your Medicare premiums two years in the future (when the difference will be higher). That's because, for example, you report your 2022 income on a tac return that you file in the winter or spring of 2003. When Medicare sets your premium for 2024, the most recent income figure that it can access is that 2022 figure. Thus, you won't know until two years later that you're subject to the surcharge. And it will be impossible to undo your 2022 financial transactions in late 2023 or early 2024 to try to eliminate the surcharge.

Bonus Tip

Here's something to think about if you have only a limited balance in your Heath Savings Account in retirement and are concerned that your income one year may place you in a higher Medicare premium bracket: Limit your withdrawals. That's right, it may make sense to pay some qualified expenses with withdrawals from your tax-deferred IRA or 401(k) during years that you're nowhere near the next bracket or you're firmly in a higher one without the threat of jumping to another.

Why not enjoy the benefit of tax-free withdrawals for all qualified expenses? If your Health Savings Balance is low, saving that money for years when you are close to the next tier will give you a better opportunity to stay below the MAGI ceiling. In other words, if your income one year is $125,000 (say, you sold a small business), consider reimbursing your qualified expenses with money that's built into your MAGI calculation. That way, in a year that you're closing in on the $91,000 ceiling, you'll have funds to pay your qualified expenses without bumping your income into the next tier and surcharge.

The Bottom Line

Americans who save diligently for retirement often don't understand the tax implications of their savings during the distribution phase. Decisions that they make prior to retirement when determining how much to save and invest in various accounts (like a tax-deferred versus Roth retirement account and a Health Savings Account) will affect their taxes, the percentage of their Social Security benefit included in taxable income, and the amount that they pay for Medicare premiums.

Even those who don't understand these concepts but who enter retirement with some money in a Health Savings Account can use those balances strategically to stay below the next surcharge threshold. But only if they understand how IRMAA works and the role that a Health Savings Account (or Roth IRA) can play in this strategy.

Now, you understand the concept. The proverbial ball is in your financial court.

#HSAWednesdayWisdom #HSAMondayMythbuster #HSA #HealthSavingsAccount #TaxPerfect

William G. (Bill) Stuart

Nationally recognized expert on reimbursement account strategy and compliance, particularly Health Savings Accounts and ICHRAs 🔹Writer🔹Author🔹Speaker🔹Educator🔹Strategist

1y

Understand the tax implications of your sources of income durin gthe distribution phase of retirement is SO important. IRMAA is a concept to understand.

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