The Surprise Retirement Expense
As you build wealth and plan for your retirement years, are you taking into account all of the foreseeable expenses in your plan? We don’t have a crystal ball and everything we consider is an estimate and a prediction, but there are some expenses that come as a surprise to many retirees that we can, and should, plan for. One of these expenses is IRMAA, the Income Related Medicare Adjustment Amount.
What is IRMAA?
IRMAA is an additional amount that you may have to pay in addition to your base premiums for Medicare. These additional amounts are based on your income-more specifically your modified adjusted gross income from your tax return. These IRMAA surcharges are in addition to your base Medicare premium and they can be significant. For 2025, they can be as much as $443.90 per month, per person for Medicare Part B. Then, there’s an additional $85.80 per month, per person for Medicare Part D. For a married couple affected by this IRMAA level, this translates to an additional expense of more than $12,000 per year. There are six IRMAA brackets with fees ranging from $74.00 to $443.90 per person per month for Medicare Part B and from $13.70 to $85.80 per person per month for Medicare Part D.
The IRMAA is calculated each year. So, a single year with unusually high income does not mean you will be subject to a high IRMAA for many years to come. And, in certain cases such as a retirement year when your income decreases, you do have the option to appeal an IRMAA determination.
What income counts?
What income is included when they determine whether IRMAA applies to you and at what level? All income that is included in your Modified Adjusted Gross Income is included. This incorporates capital gains income, the taxable portion of your social security benefits, and taxable distributions from your retirement accounts. It includes dividends and interest as well as income from the sale of a home or business. And, keep in mind, they use an adjusted Gross income number, not a taxable income number. The threshold is tested before your deductions are applied.
How does this affect retirement planning?
I think the most important factor here is to be aware of IRMAA. Quite often, when we hear of folks considering the pros and cons of various financial strategies, the total cost of a strategy isn’t considered. Most of these strategies can affect eligibility for tax credits. Or, they can subject you to additional taxes like the Net Investment Income Tax and additional fees like the IRMAA. Awareness of an additional tax or fee does not necessarily mean that it should be avoided at all costs; it is simply a potential additional cost that should be considered.
Consider RMDs
Be sure to consider the effect of Required Minimum Distributions (RMDs) on your future financial picture. For those with large retirement account balances, RMDs can cause unwanted additional taxes, including IRMAA, in the future. The question of whether to execute certain strategies like Roth conversions, should be considered with all of the associated costs both now and in the future, not just federal income tax rates. Read more about considerations for Roth conversions here.
Consider Survivorship
Nobody likes to think about their demise. However, when it comes to income planning in retirement, it’s important to keep in mind how a surviving spouse will be affected by financial decisions. How large will the total amount of retirement funds be for the surviving spouse? And following from that number, how large will RMDs and therefore taxes and IRMAA be? The same income number for a single person household will cause a much larger IRMAA than it would for a Married Filing Jointly household.
Consider Control
One factor to keep in mind as you design your financial strategies is control. How much control do you have over your income – the amount and the timing? We’ve discussed this before with respect to forced income. You have little to no control over the timing of deferred compensation payouts, social security income or RMDs in the moment. But are you getting the most benefit you can from the control you do have? Roth conversions give you some control over when you will incur a tax bill. Avoiding large contributions to retirement plans and using taxable accounts to save for retirement instead allows you to retain some more control over your retirement savings. This control includes access to the funds, and the investment options available for the funds. It also includes the timing and type of taxation on the growth of the funds that you save for retirement outside of the retirement plan. However, each of these items comes with a tradeoff – you need to evaluate them in the context of your full financial plan.
So, what do we do about IRMAA?
First, consider the degree to which IRMAA may be an issue for you. Will your income exceed the thresholds on a regular basis early in retirement? What about when you have RMDs when you reach RMD age? Are you likely to inherit any IRA accounts that will subject you to RMDs and increase your taxable income? What other sources of income do you have? What assets can you draw on for income and how will they affect your tax situation? Are you including all types of taxes and fees that depend on your income level in your plan?
Maintaining Control
Next, consider how much control you have over each source of income and each asset. Does that degree of control change over time? For instance, when electing to participate in a non-qualified deferred compensation program at work, you have some control over the payout scheme when you elect to participate. However, you don’t have the ability to change those elections. So, the amount to defer cannot be changed once you have made the election. The payout date and schedule cannot be changed – even if you don’t need or want the income on the scheduled date. You may have no control over a triggering event like an ownership change. You have no control over market performance.
Similarly, once you have contributed funds to your 401k plan, your options are limited. You are limited to the investment options offered and the timeframe when you can withdraw funds. Some plans do not allow any withdrawals while employed. You’re also limited by age at which you can withdraw funds without a penalty. On the other hand, you can withdraw funds from your taxable brokerage account whenever you like. You’ll be subject to paying income taxes on the gain (and only the gain) from investments you’ve sold, but you’ll have few restrictions.
Keeping these factors in mind, you’ll want to devise a plan that maximizes your options in the future and, to the degree that you can, maximizes the wealth that you keep. We don’t have a crystal ball. Tax laws can and will change. Market conditions can and will change. Your lifestyle expenses can and will change. It’s important to be aware of the factors that are likely to affect you. Then you can devise a plan that accounts for their impact on you and keeps options open for future developments.
Effects now and in the future
When planning, consider the effects now and in the future. As an example, when contemplating a Roth conversion, be sure to factor in the effect of the conversion on IRMAA if you are close to Medicare eligibility or already on Medicare. In the 2nd year following the higher income due to the conversion, an IRMAA surcharge might apply. Rather than only looking at ordinary income tax brackets, remember that you may also push your capital gains into a new tax bracket. You could also become subject to the Net Investment Income Tax (NIIT) or subject more of your income to the NIIT. Will the conversion cause you to lose valuable tax credits such as the child tax credit? Or, might you lose access to deductions like QBI due to your new taxable income level? Again, these aren’t showstoppers, but they need to be considered as part of the full impact of the strategy on the near-term financial picture.
Then, consider the effect of the strategy on the future financial picture. Perhaps a Roth conversion now will subject you to a higher marginal tax rate this year, but it may reduce the effective cost to you in the future when you have to take RMDs. A Roth conversion executed now could have these effects in the future:
- allow for a smaller RMD
- a smaller effective federal income tax bill
- a smaller state income tax bill
- a reduced or eliminated future IRMAA surcharge
- avoidance of the Net Investment Income Tax
- preserved eligibility for certain tax credits or deductions
These potential benefits are all while being able to withdraw funds from your Roth IRA in the future, tax-free, for your lifestyle expenses. Read more about considerations for evaluating Roth conversions.
Key Takeaway
The IRMAA affects those with high incomes as determined by the Social Security Administration. The surprise comes because many people focus only on whether they’ll have enough money to retire and meet their desired lifestyle expenses. They don’t consider this additional fee and it can be significant. Further, many folks never considered themselves having a high enough income to be concerned about these types of fees or taxes. But, with diligent saving and the power of compounding, many retirement accounts will grow far beyond the owners’ dreams. However, RMDs often bring about a new set of challenges for those who have diligently saved and invested for years.
Seek advice from qualified advisors
Before setting a date for retirement, consult a qualified professional. A financial planner who considers your whole financial picture can work with you to devise a strategy that pursues your goals while taking these factors into account.
This article is intended to be educational and thought-provoking rather than financial, legal or tax advice. When we work together in a financial planning engagement, we discuss your unique personal situation and your unique goals. During our financial planning process, we examine these factors and many others to determine appropriate financial strategies for YOU.