You may not be aware, but Medicare is means-tested. Earning above certain thresholds during retirement could see you get hit with a Medicare income-related monthly adjustment amount (IRMAA), which is a fancy way of saying that you’ll pay more. This can be a nasty surprise.

Case in point: a 65 year old married couple retiring this year can expect to pay about $300,000 over the rest of their lives for medical care, according to Fidelity’s latest annual retiree health care cost estimate. That’s a staggering sum. Bear in mind that this isn’t neat and linear cost you can work into an annual budget. Your health fails you. You see a doctor. You pay them gobs of money and (hopefully) get back on your feet. It’s a year of exorbitant medical costs and one that may see you raid your retirement accounts, which are 100% taxable, to pay for care. Finding out you qualify for an IRMAA surcharge after shelling out so much already is a bitter pill to swallow. Fortunately, there are six different routes you can take to avoid these surcharges.

But first, here’s what it actually takes to get hit with these surcharges in the first place.

Source: Medicareinteractive.org

These brackets are fungible and adjust each year based on changes in the Consumer Price Index for Urban Consumers (CPI-U). This index is what most refer to when they talk about inflation in the US. Additionally, social security uses information from the tax return you filed 2 years ago to determine if you will pay a surcharge.

The Common Traps

We see two common areas where people inadvertently hurt themselves. The first is overspending. You may have put off big trips and large purchases for the onset of your retirement. You need to be careful if the dollars to pay for these things are in tax-deferred retirement accounts. Distributions are 100% taxable and pulling out too much can tip the scales against you.

The onset of required minimum distributions is another pitfall. You are required to start withdrawing money from your retirement accounts at age 72. The amount you have to withdraw is based on your life expectancy and total account size. The life expectancy tables are standardized by the IRS. Your account size is not. The larger the end-of-year account value, the larger the required minimum distribution. Deferring withdrawals from your tax deferred accounts will increase their size. This in turn increases the size of the mandatory minimum distribution. If you’re not careful these may just catapult you into a higher bracket.

Clever Strategies for Avoidance

Create a balanced distribution plan

To piggy-back on the above, a common planning tactic is to defer taxes for as long as possible by delaying distributions from retirement accounts to age 72. This allows your retirement accounts to continue to grow and compound unencumbered by distributions, which leads to large balances and large required minimum distributions.

A more balanced distribution strategy that smooths taxes over time, as opposed to deferring and then lumping into later years, may help you avoid an IRMAA surcharge.

Convert to a Roth IRA

If you don’t need the income from tax-deferred accounts immediately, then look strongly at Roth IRA conversions. This strategy moves money from your tax-deferred accounts into a Roth IRA. You can convert as much or as little as you like. There are no minimum or maximum annual amounts. Doing so, however, is taxable.

This strategy has several benefits. You reduce the size of your tax-deferred accounts, which in turn reduces the amount you’ll use to calculate your required minimum distributions at age 72. You move money from your taxable ledger to your tax-free ledger. This could lower your lifetime tax liability depending on how much growth you see and how long you live.

Critically, Roth IRAs DO NOT have a required minimum distribution. There are no rules forcing you to pull money out of these accounts. If your needs are met with other income sources like pensions, social security, and other savings, then this money can grow and compound tax free for the rest of your life. You’ll avoid distributions at age 72 and, if planned well, avoid any IRMAA surcharges.

Do note, however, that a Roth 401k does have a required minimum distribution. Consider moving your Roth 401k to a Roth IRA prior to age 72 to avoid forced withdrawals.

Use a Qualified Charitable Distribution (QCD)

If you don’t need the income from your retirement accounts, or if you’re already making charitable donations on a regular basis, then look hard at QCDs. These allow you to donate money directly from your IRA to a qualified charity of your choice. The donation counts towards satisfying your annual required minimum distribution but doesn’t require you to recognize the income! This means you don’t need to itemize your deductions in order to claim this charitable contribution, which is a big win with the increased standard deduction that came about in 2017.

If there is a year where you are close to being bumped into an IRMAA bracket, a QCD may be just the tool needed to bump you back down out of IRMAA range. Do note that there is a $100,000 per person QCD limit.

Don’t put all of your eggs in a single tax basket

There’s a strong draw to save money into tax-deferred retirement accounts while you’re working. After all, you get a nice tax deduction for every contribution made. But this can limit your options down the road by limiting the tax diversity of your portfolio.

Moreover, substantial changes to tax law have historically come every 10 or so years. The best strategy today could be the worst when you retire. Diversity is as much about having a broad swathe of asset classes in your portfolio as it is about having those assets in the right kinds of accounts. Consider including Roth accounts and taxable accounts in your savings strategy to give yourself the best shot of avoiding IRMAA charges.

Reverse Mortgages

The equity in your home likely represents a significant portion of your net worth. In most cases this equity remains “untapped”, but reverse mortgages offer a way to draw on this tax-free.

The stigmas around reverse mortgages are strong, but if utilized correctly these can be a powerful tool. They can help you avoid IRMAA surcharges as well as “bracket creep”. If you can avoid hitting a higher tax bracket through the use of a reverse mortgage then it may be worth considering.

The origination costs can be high and there are some important caveats to how these products work that are important to know. Our best advice is to consult an expert before jumping into something like this with both feet.

Plain, boring, cash-value life insurance

Distributions from cash-value life insurance can also be an avenue to help you avoid IRMAA surcharges. Withdrawals from these policies are cash free when done correctly just like a reverse mortgage. However, not all policies will qualify. Some policies may collapse and others may lose certain contractual guarantees if distributions are taken. You must be careful when utilizing this asset to suppress your taxable income and avoid IRMAA surcharges.

Fighting over an Incorrect IRMAA Assessment

Last but not least, you can always go to the mat and fight these charges. The Social Security Administration recognizes several qualifying reasons that will allow you to appeal by requesting a reconsideration of the initial determination. Success isn’t guaranteed here by any stretch. The best course of action is still to plan for avoidance rather than confrontation.

Conclusion

Take a holistic view of your investments and recognize that saving for retirement is a completely different animal from spending in retirement. Develop a coordinated withdrawal strategy for retirement. Hire an advisor to help you if you aren’t sure how and build a plan that keeps you from inadvertently bumping into higher brackets and incurring IRMAA surcharges!