The Mysterious Risk of IRMAA. The Cost May Be Higher Than You Think
The risk of IRMAA (Income-Related Monthly Adjustment Amounts) looms like a shadow over retirement planning, often bringing unexpected costs that can surpass initial estimates. It's a hidden financial pitfall that many don't anticipate, potentially escalating the price of health care in your golden years.
In retirement, when it comes to your health coverage, and you are 65 years of age or older, there is only one option: Medicare.
Thankfully, for those who properly insure themselves and use the system prudently, Medicare is fantastic coverage. The bad news is that Medicare is not free and does decrease your Social Security benefits, too.
Federal regulations state that to receive any Social Security benefit, you must enroll in Medicare when you are eligible and no longer have health coverage through an employer. They also state that your Social Security benefit will automatically pay most of your Medicare premiums.
Failure to enroll in Medicare while on Social Security, without proper health coverage, will result in the immediate forfeiture of all Social Security benefits.
The other bit of bad news when it comes to Medicare is that depending on how much income you generate while on it, you may wind up paying an extra tax as well.
This unknown tax through Medicare is called IRMAA.
What is IRMAA?
IRMAA is short for Medicare's Income Related Monthly Adjustment Amount.
According to the Code of Federal Regulations, IRMAA is:
An amount that you will pay for your Medicare Part B and D coverage when your modified adjusted gross income is above certain thresholds.
Ultimately, the more income you have in retirement, the higher your Medicare Part B and Part D premiums will be, and again, this cost comes directly from your Social Security benefit.
Who Does IRMAA Impact?
The Social Security Administration states that IRMAA is for anyone enrolled in Medicare and who has a modified adjusted gross income (MAGI) of over $103,000 for individuals and $206,000 for couples.
Will You Really Reach IRMAA?
Reaching IRMAA all comes down to how much income you have in retirement. The more income you generate, the greater the chances that IRMAA will impact your retirement.
Looking at the projections from a recent study by the Trustees of Medicare, the chances of you reaching IRMAA over the next 8 years are going to greatly increase.
In 2023, over 15% or 6.8 million eligible Medicare beneficiaries reached IRMAA, and by 2032, the percentage will grow to over 25%, with more than 13 million retirees being impacted by IRMAA.
What Counts as Income for IRMAA?
The simplest way to find out if your income counts towards IRMAA is to ask yourself if your income is visible to the Internal Revenue Service (IRS) or not.
If the IRS does recognize your income, then the chances of reaching IRMAA are even greater. If not, then you have nothing to worry about, especially when it comes to your Social Security Net Benefit.
The Social Security Administration (SSA) defines IRMAA income as being your Modified Adjusted Gross Income (MAGI) which consists of your:
Adjusted gross income (AGI) and tax-exempt interest or everything on lines 2a and 11 of the 2022 IRS tax form 1040.
Your MAGI that contributes to the IRMAA includes:
- Salaries and wages
- Taxable Social Security benefits
- Earned tips
- Interest earnings
- Capital gains
- Dividend income
- Income from stock options
- Pension distributions
- Rental revenue
- Royalties
- Alimony received
- Gambling proceeds
- Debt forgiveness
- Withdrawals from tax-deferred investments.
Yes, your savings in your Traditional 401(k) or Traditional IRA count towards IRMAA. So, the more you save for retirement using a tax-deferred strategy, the higher your Medicare premiums are going to be.
In a nutshell, IRMAA is driven by your Traditional 401(k) or Traditional IRA and your taxable portion of your Social Security benefits.
What Does Not Count Toward IRMAA
What does NOT count towards IRMAA is, unfortunately, a much shorter list as it only includes:
- Distributions from Roth Accounts, Health Savings Accounts, and 401(h) Plans.
- Portions of income from Non-Qualified Annuities.
- Loans from Primary Residences and Life Insurance Policies.
A simple rule of thumb: if you have what you consider to be at least a decent amount of money saved in your Traditional 401(k), then you are most likely going to reach IRMAA at some point in retirement.
The other rule for the other thumb: if you have all your retirement savings in Roth Accounts and Life Insurance, you will never reach IRMAA…ever!
Is IRMAA a Real Problem?
For those who reach IRMAA today, the extra tax on top of their Medicare premiums may not seem all that bad as it can total between $1,990 and $12,012 a year for couples.
The issue is where the Trustees of Medicare are projecting it to be, as Medicare costs, including IRMAA, are inflating by over 7.25% annually through 2032.
By 2032, the cost of IRMAA will increase to between $3,400 and $20,000 annually for a couple of years if the recent studies from the Trustees are accurate and inflation remains consistent.
IRMAA's Other Impact – Social Security
Besides possibly costing thousands of dollars in extra taxes through Medicare premiums, IRMAA, again, comes directly out of your Social Security benefit.
According to the Social Security Board of Trustees, the cost-of-living adjustment (COLA) each retiree receives annually to keep up with inflation is going to be no higher than 2.40% through at least 2032.
With Medicare premiums and IRMAA inflating by more than 7.25% over time, it is only a matter of time before your Social Security benefit will decrease.
Interestingly, Medicare and IRMAA are inflating by more than 3 TIMES, and your Social Security benefit will increase each year.
Avoiding IRMAA Altogether
How do you avoid IRMAA altogether? You now know that IRMAA is all about your income and, more specifically, about the income you generate, which the IRS will see on lines 2a and 11 of the 2022 IRS Form 1040.
Your goal should be to take advantage of what the IRS does not see, which consists of Roth IRAs and 401(k) 's, Non-Qualified Annuities, and, more importantly, Life Insurance.
We understand that Life Insurance may not be the sexiest financial instrument out there, but it accomplishes three things as well as it can:
- Provide your family with protection; God forbid the tragedy or your death hits you.
- Generate a source of tax-free revenue in what is known as the Cash Value, and this revenue will not count towards IRMAA or the taxation of your Social Security benefits.
- Allow you to insure yourself in the event you need to pay for Long-Term Care Expenses.
There is no other financial instrument, like Life Insurance, that can provide you with all of this at the same time.
Self-Funding Future Long-Term Care and IRMAA
If you do not have Long-Term Care Insurance, you will probably have to sell off assets, perhaps from an IRA or 401(k), to pay for the expensive care many of us will need when we get older.
Yes, not only are you using your own money to pay for care, but selling off assets to pay for future long-term care can create a problem with IRMAA. When you sell an asset, you are considered to have "capital gains" income. Capital gains income is added to your income when determining your IRMAA surcharge.
For example, if you sell a stock that has appreciated in value, you will have to pay capital gains tax on the profit from the sale. This capital gains income will be added to your AGI, which will increase your IRMAA surcharge.
Proceeds from a qualified Long-Term Care Insurance policy (either traditional or hybrid) come to you tax-free and will not be considered income.
For more information on IRMAA and to further your retirement plans to avoid this tax, we encourage you to contact an IRMAA Certified Professional, which you can find here.
About the Author
Dan McGrath, Co-Fonder of IRMAA Certified Planner, and best-selling author known for "What You Don't Know About Retirement Will Hurt You" and the yearly "A Guide to Understanding Medicare." His expertise also extends to developing patented retirement planning software focused on taxes, Medicare, and IRMAA's impact on retirement income.
Dan McGrath
Contributor since November 8th, 2023
Editor's Note
Self-funding future long-term care is a strategy that some individuals consider for their retirement plan. However, this approach carries several risks that can complicate your financial stability and family dynamics.
One of the primary challenges is the timing of markets relative to when care is needed. Market volatility can significantly affect the value of your investments; if the market is down when you require care, you may have to sell assets at a loss, which can erode the nest egg you've worked so hard to build.
Moreover, the cost of long-term care is rising steadily. As healthcare advances, so does the cost associated with prolonged services, specialized care, and the increasing demand for qualified caregivers.
Relying on personal savings to cover these expenses can quickly deplete resources, especially if care is needed for an extended period. This financial strain is compounded by the potential impact of IRMAA, which can increase your Medicare Part B and D premiums based on your income level, including withdrawals from retirement accounts that are considered taxable income.
The implications of IRMAA are often overlooked in retirement planning, yet they can substantially increase the cost of long-term care. If you need to make large withdrawals from your retirement savings to pay for long-term care, not only could this push you into a higher tax bracket, but it could also trigger higher Medicare premiums, further straining your finances.
The family impact of self-funding long-term care is another critical consideration. In the absence of a dedicated long-term care plan, family members are often tasked with making difficult decisions regarding the type and extent of care, as well as managing the financial logistics of paying for it. This can lead to stress and potential conflict within the family, as different members may have varying opinions on the best course of action. Furthermore, liquidating assets to fund care can involve complex decisions about which assets to sell, considering tax implications and the timing of sales, adding another layer of responsibility and pressure on your loved ones.
In light of these challenges, self-funding long-term care without a structured plan can lead to significant financial and emotional difficulties. It underscores the importance of considering instruments like Long-Term Care Insurance, which can provide a more predictable and secure method of funding care without the associated market risks, tax implications, and family burdens.
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