When saving for retirement, it is critically important to factor health care costs into projections and plans. Due to upcoming changes in Medicare, this will be even more important.
Medicare’s coverage is separated into four Parts: A, B, C, and D. The changes will primarily affect Part B, which covers doctor appointments, emergency room visits, and tests, and is paid for by premiums based on the beneficiary’s income. The higher the earner, the greater the cost, according to what’s known as Medicare Means Testing.
Medicare Means Testing is broken down into brackets, which establish different income amounts as the thresholds for premium surcharges. However, only certain types of income serve to increase a person’s position in these brackets. The measurement of income is defined as Modified Adjusted Gross Income (MAGI) and includes salary/wages, capital gains, IRA distributions, and pension distributions. Fortunately, there are other sources of income that can serve to reduce a person’s bracket position, such as life insurance policies, Roth 401(k)s, and health savings accounts, among others.
In 2018, Medicare Means Testing thresholds will be lowered, increasing Part B costs for some beneficiaries. It is important to note that while these changes will not take effect until 2018, Medicare Means Testing applies a two-year lookback. This means that a person’s income in 2016 will be taken into consideration when determining their premiums for 2018.
Below are the new income brackets as they will appear after the change takes effect in 2018.
|Medicare Means Testing Brackets 2018 and Beyond|
|Individuals||Couples||% Change in Cost|
Since the established brackets are not indexed to inflation, many future middle class retirees may be subject to Medicare surcharges. To illustrate the impact, let’s look at a 40-year-old male who is planning to retire at the age of 65. For the purposes of this example, it is assumed that his income is increasing annually at a rate of 3%.
|Current Earnings||Projected Earnings at 66||Means Testing Threshold||Projected Costs: Parts B and D||Total Increase|
|–||<$85,000||$85,000 or less||$548,158||–|
As you can see from the table above, a 40-year-old currently earning $40,000 annually who will never earn more than the equivalent of $40,000 throughout his or her career, will fall into the second income bracket and will be responsible for a 37% premium surcharge on both Medicare Parts B and D coverage. Future earnings of $86,264 may result in cumulative retirement surcharges of $197,330.
Additionally, a 40-year-old earning $75,000 today will fall into the top income bracket at age 65, subjecting them to over $1 million in retirement surcharges.
Now, most of us would not consider a 40-year-old earning $40,000 to $75,000 annually to be “affluent” by today’s standards. Under current Medicare regulations, future retirees earning the equivalent of $40,000 to $75,000 in today’s dollars will be responsible for $197,330 to over $1 million in income based surcharges.
Now, some of you might be thinking that reducing your income isn’t an option in retirement, and as such, there’s nothing you can do to reduce or eliminate surcharges. Fortunately, this is not an accurate assumption. Investments like Roth 401(k)s, health savings accounts, and life insurance policies provide income that can actually reduce someone’s MAGI. This is even more critical given the recent changes to Social Security filing strategies, which have the potential to reduce an individual’s Social Security benefits by as much as $60,000 in the first four years of retirement.
In conclusion, the changes to the Medicare Means Testing brackets have the potential to pose significant challenges to retirees, but with a diverse portfolio, it is possible to combat the negative effects of these changes.