Successful retirement savers often find themselves in a high tax bracket during retirement (pensions, social security, RMDs, etc.). One of the downsides, in addition to a higher tax bill, is getting hit with Medicare IRMAA.
Listen now and learn:
- How IRMAA works
- Strategies for retirees to avoid IRMAA
- How to plan for IRMAA while you’re still working
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Show Notes
Taylor Schulte is the founder of Define Financial, an RIA that specializes in assisting people nearing or in retirement. This group of investors has a few common pain points.
The first is taxes in retirement. Many people have accumulated a substantial amount of wealth in pre-tax Traditional IRAs. At age 72, the IRS comes knocking on the door to force them to take money out – so they know there’s a big looming tax bill in retirement.
A second common pain point is creating an income. Our typical client nearing or in retirement has done a good job saving, but they don’t necessarily have a plan for turning their savings into an income stream.
A third common area we assist clients with is navigating healthcare expenses. Making good choices with Medicare and IRMAA surcharges are a big part of this and the IRMAA surcharges, in particular, catch a lot of people off guard.
Taylor wrote a comprehensive blog post on IRMAA, so this is the focal point of our conversation.
These are my notes…
What is IRMAA? (2:45)
Successful retirement savers are generally going to face potential IRMAA charges because they have done such a nice job of putting money away into tax-deferred accounts. Even people who weren’t ever in the top tax brackets during their career can get into a higher tax bracket than they expected once pensions, Social Security, and Required Minimum Distributions (RMDs) kick in.
A key theme we hit on with retirement planning and tax planning is the importance of being proactive. A lot of good retirement savers, particularly the do-it-yourself investor, enjoy the early years of retirement when their income is low and suddenly are scrambling at age 72 when both RMDs and Social Security force their income higher.
IRMAA stands for income-related monthly adjustment amount. It represents an increase to your Medicare Part D and Part B standard monthly premiums. If you have too much taxable income, you get hit with a higher Medicare monthly premium.
IRMAA is based on a Medicare-specific form modified adjusted gross income (MAGI) from two years ago. For example, the IRMAA brackets in 2022 are based off your MAGI from 2020 (and 2019 if that amount is not available). So you must think about how what you’re doing this year is going to impact you two years or even ten years from now.
This type of planning speaks to where a financial advisor ought to be adding value. It used to be that an advisor was just an investment advisor that gives you an asset allocation, selected funds, rebalances, etc.
Read More: The Difference Between Investment Management vs. Wealth Management
One of the most common things I hear us saying with new clients that are nearing or approaching retirement is: “We should run a tax projection.” Whenever you’re moving large amounts of money whether it’s liquidating assets to meet lifestyle expenses, making charitable gifts, doing partial Roth conversions, switching out of municipal bonds, etc – these things can trigger IRMAA considerations.
Common Misconceptions About IRMAA (6:00)
It’s common to hear retirees complain about income, but as our mutual friend says: “Give me your income and I’ll pay your taxes.”
So yes, the IRMAA surcharge is annoying, but in some cases, people foolishly avoid the surcharge rather than making moves that benefit them more in the long term.
A classic example is with partial Roth conversions, which can dramatically lower your taxes over the course of your lifetime but might cause a relatively smaller IRMAA surcharge two years from now.
Good tax planning doesn’t look at any decision in a vacuum. It’s important to look at how decisions impact you over the course of your lifetime and not just one year.
Don’t let IRMAA prevent you from making meaningful reductions in your lifetime taxes.
This mistake shows up more often among people who don’t use a wealth manager that proactively helps with taxes.
Generally speaking, when you rely on an accountant – particularly if they are more of a tax preparer than someone you meet with regularly – they’re mostly focused on minimizing taxes in the current year. This isn’t necessarily their fault. Accountants and tax preparers simply aren’t as well positioned as a comprehensive wealth manager who has a holistic view of your life and is part of in-the-moment conversations when money decisions are being made.
Strategies to Avoid IRMA (8:40)
Doing Roth conversions earlier in life or retirement can reduce future RMDs, which in turn lowers income to help avoid or reduce IRMAA.
Another strategy is charitable giving in a couple of different ways. You can contribute cash, appreciated assets, or make qualified charitable distributions (QCDs) directly from your IRAs. One of our favorite strategies, though, is using a donor-advised fund to make multiple years’ worth of gifts all at once to help offset a higher income year or the tax liability caused by a planning strategy such as partial Roth conversion.
And while you’re working, obviously contributing to tax-deductible retirement accounts will help keep your income lower as well.
See More: The 10 Best Ways to Avoid (or Reduce) IRMAA
Other Considerations As You Approach Retirement (11:30)
It’s hard to make big pivots once you’re in retirement, so many of the decisions you make leading up to retirement are important for having more control over your taxes.
Any opportunity you have to get money in a Roth is something you want to consider.
How aggressively someone should consider it is truly a case-by-case basis. But consider the situation where the vast majority of your retirement savings is in a Traditional IRA and/or 401(k) plus taxable savings. If you’re five years from retirement, you already know there is a giant tax bill looming, so why make the problem worse? Maybe you should be filling those post-tax Roth buckets in the final years leading up to retirement.
For people under the age of 50 who are still following along, we did briefly touch on the importance of younger workers being intentional and proactive about when and how you rollover former employer retirement plan accounts so that you can do cheaper Roth conversions earlier on. Those sorts of changes can make a massive difference in your tax planning in retirement.
See More: Investing By Age Series (20s, 30s, 40s, 50s, and 60s)
Under the theme of reducing MAGI, you can also look at your portfolio – your allocation, the types of investments you own, and the types of accounts you utilize.
Within your taxable brokerage accounts, consider:
- Avoiding high-turnover funds, which tend to generate more short-term capital gains that are taxed as ordinary income
- Utilize ETFs instead of mutual funds
- When possible, keep your passive index funds in these accounts and less tax-efficient assets in your qualified accounts
- Minimize your exposure to bonds with higher taxable income if you are in the 32% tax bracket or higher
Keeping in the theme of things that are within your control that can have a big impact is a withdrawal strategy.
There are several withdrawal strategies supported by academic evidence, so choosing the right one for you really depends on your goals. Taylor’s preference is for a dynamic withdrawal system that adjusts for different market environments, which he describes during our conversation in detail.
Resources
- Taylor’s comprehensive blog post on IRMAA
- Medicare-specific form modified adjusted gross income (MAGI)
- The Difference Between Investment Management vs. Wealth Management
- How Tax Projections Help you Make Better Financial Decisions by Plancorp
- The Tax Benefits of a Partial Roth conversion by Peter Lazaroff,
- Using A Donor-Advised Fund
- The 10 Best Ways to Avoid (or Reduce) IRMAA
- Investing By Age Series (20s, 30s, 40s, 50s, and 60s)
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Long-term investing made simple. Most people enter the markets without understanding how to grow their wealth over the long term or clearly hit their financial goals. The Long Term Investor shows you how to proactively minimize taxes, hedge against rising inflation, and ride the waves of volatility with confidence.
Hosted by the advisor, Chief Investment Officer of Plancorp, and author of “Making Money Simple,” Peter Lazaroff shares practical advice on how to make smart investment decisions your future self with thank you for. A go-to source for top media outlets like CNBC, the Wall Street Journal, and CNN Money, Peter unpacks the clear, strategic, and calculated approach he uses to decisively manage over 5.5 billion in investments for clients at Plancorp.
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