Medicare income-based surcharges have always been a concern for high-income clients—exceeding the income-based thresholds can increase a client’s Medicare expenses by more than 200% during retirement.
Unfortunately, a little known provision in the recently enacted “Doc Fix” law is set to modify the income thresholds in a manner that will subject even more clients to the highest premium surcharge rates. Fortunately, there are planning techniques that can help minimize the impact of the new rules—and save your clients thousands of dollars each year by avoiding or reducing the Medicare income-based surcharges in 2018 and beyond
The Doc Fix Law
The current Medicare income-based surcharge rules increase the cost of premiums for Medicare Parts B and D for clients with modified adjusted gross income (MAGI) that exceeds certain threshold limits. Importantly, Medicare uses a two-year look-back period that is often overlooked by both clients and advisors, meaning that the wages a client earned in 2013 are used in determining the client’s liability for income-based surcharges today.
The Medicare Access and CHIP Reauthorization Act of 2015 (informally known as the "Doc Fix law") includes a provision that will modify the scale for determining the various levels of income-based surcharges that higher income Medicare recipients must pay.
As discussed above, Medicare income-based surcharges are determined based on a sliding scale that uses the recipient's modified adjusted gross income (MAGI) to determine liability for Medicare premium costs. Five tiers of income levels currently exist, and the amount of an individual's income-based surcharge is determined based upon the tier in which his or her income falls.
Currently, the upper income limit for the third tier is $160,000 for a single taxpayer and $320,000 for a married couple filing jointly. Beginning in 2018, however, those income limits (which are actually based on 2016 income) will set the lower limits for the fifth tier, which imposes the highest income based surcharge. As a result, more high-income clients will find themselves pushed into the highest tiers, which can result in premium increases of over $7,000 per year for a married couple.
Mitigating the Impact
Because MAGI includes most types of traditional income—including wages, Social Security, IRA and 401(k) distributions, dividends, earned interest, and capital gains—the risk that a client will be liable for Medicare surcharges, at least in the early years of retirement, is very high—and the Doc Fix law is likely to increase that risk.
The MAGI calculation used by Medicare to determine whether income-based surcharges will apply includes a wide range of income. For example, selling a house or receiving a bonus prior to Medicare qualification can push a client over the threshold.
There are, however, types of tax-preferred products and vehicles that can help clients reduce their overall MAGI and potentially avoid the Medicare surcharges.
Income received on a tax-free basis in retirement is not included in calculating a client’s MAGI. This means that income drawn from after-tax retirement savings vehicles, such as Roth IRAs or Roth 401(k)s, is excluded from a client’s MAGI. Similarly, income drawn from a health savings account, which also allows tax-free savings to accumulate over the years, is excluded.
Further, income from tax-preferred financial products—such as annuity payments received from a nonqualified annuity or loans taken from a whole life insurance product—will not increase a client’s MAGI for Medicare means testing purposes.
Conclusion
While the new Medicare income thresholds do not become effective until 2018, it is the client’s income from next year that will actually be used to determine where he or she falls on the income-based surcharge scale—and the time to plan to minimize MAGI in 2016 is now.
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