In order to prepare for potential means-testing surcharges, portfolios must be adjusted to account for retirement income distribution – not just accumulation. Because not all sources of income count as MAGI, knowledgeable advisors can help retirees significantly reduce the impact of these surcharges – if not eliminate them altogether, by investing in specific products that do not increase MAGI.
In order to fully comprehend, manage, and even reduce the impact of surcharges, it is necessary to understand that MAGI incorporates almost every potential source of income – including working in retirement, Social Security, pensions, required minimum distributions, earned interest, and capital gains. There is also a two-year look-back period. This rule can become especially troublesome at age 70½, when required minimum distributions (RMDs) must be taken, or when a spouse passes away, which may leave an income stream that could place the lone survivor into a higher income bracket.
It is also important to note that income thresholds are not indexed to inflation, and if Medicare is to remain viable as millions more enter the system, it is unlikely that Congress will consider raising them any time soon. As a result, as household incomes rise with inflation, it is only a matter of time before more future Medicare subscribers—and not necessarily just affluent ones—find themselves in higher thresholds.
This policy will also greatly impact those who collect pensions. Here’s a brief example.
Mary is a 55-year-old New York City public school teacher planning to retire at 66 with an annual pension of $80,000. She also has a 403(b), an IRA and other investments, which that are projected to generate an additional MAGI income stream of $10,000 annually. Mary will be placed in the second income bracket, (see Table from last week’s column), which will cost her more than $71,000 in Medicare surcharges through her retirement. However, if Mary can reduce her MAGI by $5,000 annually, she will move into the first income bracket and avoid the surcharges.
To summarize: a middle-class individual with a pension and a few investments is affluent enough, according to Medicare, to end up in the second or third income bracket and face substantial surcharges—an expense that most have probably failed to factor into their retirement budgets.
Once again, advisors who understand means testing can employ strategies to lower MAGI in retirement, including taking advantage of Roth IRAs, Roth 401(k)s, qualified annuities, life insurance policies, and health savings accounts (HSAs). Selling a house two or more years prior to enrolling in Medicare, so that the proceeds do not increase MAGI, can also help avoid surcharges.
Ultimately, budgeting for lifetime health care costs, understanding the impact of MAGI, and selecting investment vehicles to minimize or eliminate Medicare surcharges should be the fundamental building blocks of any long-term financial plan.