No COLA and Hold Harmless

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The big retirement news this past month?  In 2016, Medicare Part B premiums are set to increase by 52%, and there will not be a Social Security Cost of Living Adjustment (COLA). The COLA decision should come as no surprise. For the third time in the past seven years seniors will have to make ends meet with no additional financial assistance from Uncle Sam.


Most of you may be thinking: So what? I’m not on Medicare and I don’t collect Social Security. Think again.


Whether a person retires next year or in 25 years, almost everyone is eventually going to get hit with the compounded annual growth in Medicare premiums. In order to understand why, let’s first examine how this latest increase will be implemented. Medicare has five income brackets (referred to as means-testing brackets), which ultimately determines what beneficiaries will pay in premiums.


Any current retiree who earn under $85,000 in Modified Adjusted Gross Income (or couple generating less than $170,000) and remains in the first bracket will not have to pay this year’s projected increase.

The reason? A provision called Hold Harmless, which states that Medicare beneficiaries are not required to pay more than the equivalent of Social Security’s annual Cost of Living Adjustment for Part B increases – as long as the retiree is in Medicare’s first income bracket.  Basically, the Hold Harmless provision prevents Social Security income from declining year to year. Since there will be no increase in benefits in 2016, Medicare recipients in the first bracket will not have to pay the premium increase for Part B.


Sounds like a good deal, right?


It is for the majority of current Medicare recipients…for now.  So who is taking the hit? Individuals earning over $85,000 in MAGI (and couples over $170,000), new enrollees, and those who have delayed filing for Social Security benefits will be expected to pick up the slack and could see their monthly premiums balloon by 52%.  On the surface, this may have financial implications for many older Americans who have not incorporated this expense into their budgets. What’s more, those in the second to fifth brackets will not only be responsible for the 52% increase, but also additional means testing surcharges ranging from 37% to over 200%.


This is unfortunate, but it’s only the tip of the financial iceberg.  Regardless of retirement income, every single person who signs up for Medicare in the future will now have to absorb all of the combined premium increases that will be levied between now and the day they file for benefits.


Here are the technical details.


Means testing aside, this 52% increase sets the bar pretty high. While President Obama has criticized the proposal, it is unclear if Congress will step in and lower next year’s premiums. So let’s try to wrap our heads around this: a person retiring next year with an income under $85,000 is going to have to pay $159.30 a month for Part B (up from $104.90).  Based on projected overall changes in premiums, a person retiring in four years will be responsible for a compounded annualized increase of over 6%.

You guessed it.  We’re all going to pay, and the farther away from retirement, the bigger the premium will be.  For example, a person retiring in 10 years will be responsible for a 79% increase in Part B premiums in their first year of retirement.


Now for those in the second income bracket…


Medicare Means testing offers a very subtle way for Medicare to increase revenue by charging people who can “afford” it.  In fact, two of the Income bracket thresholds will be lowered in 2018. MAGI thresholds that are not indexed to inflation guarantee that as salaries rise with inflation more and more Americans will eventually face these surcharges.

For example, a 55-year-old female currently earning $75,000 annually who plans to retire in ten years will probably be earning $100,794 prior to retirement, assuming her salary simply increases with inflation. It is also likely that this person will require approximately $86,000 in annual retirement income, placing her in the second income bracket. Her Medicare Part B premiums alone will increase from the current $1,259 to $2,254, a 79% increase.  Additionally, she will be responsible for a 37% premium surcharge for falling in the second income.


Thus, in the first year of retirement, this woman will pay a total of $3,088 in annual Part B premiums – 145% more than 2015 premiums. This does not include all of the other medical outlays, including prescription drug coverage, supplemental insurance premiums, and non-covered services, such as co-pays, deductibles, vision or dental. Don’t buy the fact that Medicare’s going up?  Aside from the tens of millions of boomers flooding the system, there is a historical precedent of Medicare increases.  In fact, since its inception, the program has yet to sustain a five-year period without raising premiums.


Back to Hold Harmless and the income brackets.


Now, more than ever, it is crucial for ALL Americans to begin restructuring their retirement portfolios to minimize the impact of means testing and take advantage of the Hold Harmless provision.  While there is nothing anyone can do about annual Part B adjustments prior to retirement, future retirees can change their investment mix to ensure their MAGI does not go above $85,000 per year, and thus retain the limited Hold Harmless protection. That way, if Social Security COLAs do not increase in a year, Medicare Part B premiums will also remain constant for beneficiaries in the first bracket. While no cost of living adjustment is certainly disheartening, avoiding an increase in Part B premiums and surcharges ranging from 37% to over 200% is not a bad trade-off.

Remaining in the first MAGI bracket may evolve as an important planning strategy for future retirees. The key is to reallocate investments in a portfolio to include products that DO NOT increase income (according to Medicare). These can include life insurance, health savings accounts (HSAs), non-qualified annuities, a Roth, and/or a Roth 401(k).  Doing so will decrease MAGI and may reduce the possibility of Part B premium increases and surcharges while still ensuring an equitable rate of return.