Filling out IRMAA, or avoiding it

There is an old saying for investors: “Don’t let the tax tail wag the investment dog.” For many years, this was good advice. But in recent years, taxes have become more complex and egregious, to the point where tax planning is now an essential part of investing.

That leads me to write about a new expense that emerged in 2007 which is catching many retired investors off-guard. The income-related monthly adjustment amount, or IRMAA, is a surcharge to the standard monthly premium for Medicare Part B and Medicare Part D plans, and it impacts people over 65 who are enrolled in original Medicare and Medicare Advantage. Although categorized as a surcharge rather than a tax, IRMAA certainly feels like an additional tax on high-income earners.

New Mexico is not known for having large numbers of multimillionaires, like Silicon Valley or New York City, so most investors in our beautiful state may not have to worry about triggering IRMAA. However, we have a surprising number of millionaires next door. These are folks who saved and invested wisely over many years and often came from middle-income backgrounds. They don’t wear their wealth on their sleeves. I applaud folks like this, and they are exposed to the danger of IRMAA.

If you file as single and your modified adjusted gross income, or MAGI, is under $106,000, or you file jointly and your MAGI is under $212,000, you will pay the standard monthly premium of $185 for Medicare Part B. Your premium for Part D is based on the Medicare drug plan you have chosen. If your income is always below the above amounts, you will not need to worry about paying IRMAA. However, many investors are getting caught by surprise by IRMAA, and it often happens too late to prevent it.

What can trigger IRMAA?

A range of activities can bump up your income and trigger IRMAA.

A Roth IRA conversion:

• The amount converted is added to your adjusted gross income in the year of the conversion. The possibility of triggering IRMAA should be considered as you plan Roth IRA conversions.

Starting Social Security benefits:

• Typically, 50% or 85% of your Social Security benefits are federally taxable, so this increases your income. As of 2022, New Mexico does not tax Social Security benefits for single filers with under $100,000 in income and joint filers with under $150,000. For higher incomes, New Mexico taxes Social Security benefits. However, state taxes do not impact IRMAA.

Starting required minimum distributions, or RMDs, for traditional IRAs:

• These begin at age 73 if you were born between 1951 and 1959, and will start at age 75 for those born after Jan. 1, 1960. RMDs are taxed as income. This increase in income may trigger IRMAA for investors who have accumulated large traditional IRAs.

A withdrawal from a traditional IRA:

• Withdrawals are taxed as income, so they may trigger IRMAA. Likewise, most annuity withdrawals are taxed as income.

The sale of property or a business:

• Anything that significantly increases your MAGI one year may trigger IRMAA.

Unusually high income from taxable investment accounts:

• Yields for individual bonds, money market funds and CDs purchased in recent years have increased significantly, which can increase the amount of interest an investor earns. (Of course, in the big picture, this is favorable.) Mutual funds, ETFs and stocks in taxable accounts can all fluctuate significantly from year to year, causing higher-than-normal capital gains and dividends for investors. This may trigger IRMAA.

Income from municipal bonds, which many retirees own in their taxable investment accounts:

• Municipal bond interest is included in the calculation for MAGI, even though it may be exempt from federal taxes.

How IRMAA is calculated

If you are over 65 and on Medicare, you can calculate your IRMAA for 2025 by looking at your MAGI from 2023. IRMAA surcharges are based on a two-year lag time. The 2025 brackets and surcharges are shown in the illustration above.

IRMAA surcharges are determined by the Social Security Administration, and the SSA offers form SSA-44 to appeal and request a redetermination of the amount you owe for IRMAA. Certain “life-changing events,” such as marriage, divorce and retirement will be accepted by the SSA as valid reasons for an IRMAA redetermination.

Unfortunately, doing a Roth conversion one year is not one of the choices offered by the SSA. An explanation that income was higher for only one year — due to reasons listed above — and will decline the following year is also not a choice offered by the SSA. The downside is that a retired investor will likely have to pay the IRMAA surcharges for an additional two years due to the two-year lag time.

I am hopeful that the SSA will become more flexible on this issue, because it seems unfair to penalize people for the additional two years if their MAGI has declined to a lower IRMAA bracket.

Example one: If you file jointly, and your MAGI is $212,000 or less, you will not owe IRMAA. However, you will still owe the standard premium for Medicare Part B, which is $185 per month. For a married couple, this totals $4,440 per year. If your MAGI is $212,001 (just $1 over the $212,000) you and your spouse will each owe IRMAA of $87.70 ($74 for Part B and $13.70 for Part D). For two people, this totals $175.40 per month, or $2,104.80 per year. This IRMAA surcharge is in addition to the standard premium for Medicare, so the total annual expense is $6,544.80. Keep in mind, the IRMAA surcharge may continue for an additional two years, even if your MAGI decreases the next year.

Example two: Let’s assume you file jointly and your MAGI is $200,000, so you are below the $212,000 limit and you will not owe IRMAA. You decide to do a $100,000 Roth conversion, which causes your MAGI to increase to $300,000 one year. This moves you up two IRMAA brackets, so you (and your spouse) will pay a combined $5,287.20 in IRMAA that year for a total of $9,727.20 for Medicare Part B and D, and you will likely pay it for the following two years.

How can wise tax planning avoid IRMAA?

• Do your Roth IRA conversions before you turn 63. This is the best way to avoid IRMAA. Medicare starts at age 65, but IRMAA always has a two-year lag time. If you are in your late 50s or early 60s, you may still be working now, so you may be in a higher tax bracket than if you wait to do Roth conversions after you retire. Comparing the taxes you would pay now versus the taxes you would pay later (plus possible IRMAA surcharges) is key to wise tax planning. There are many factors to consider with Roth IRA conversions.
• Use index funds (and other tax-efficient assets) in your taxable investment account. Unfortunately, owning municipal bonds do not help as mentioned above.
• If you are already on Medicare, plan smaller annual Roth IRA conversions that do not push you into the next IRMAA bracket, or accept that paying IRMAA is an additional cost of the conversion. The long-term benefits of having money in a Roth IRA may justify paying the income taxes and the IRMAA.
• If you have not accumulated a large traditional IRA, start funding Roth IRAs now whenever possible. Most employers offer Roth 401(k)s, which are typically a better choice, in my view, than traditional 401(k)s for people many years from retirement.

One other key point: Modified adjusted gross income is a calculation that is above taxable income on your tax return. (MAGI appears near the bottom of page one of your 1040 tax return.)

Therefore, typical tax-reduction strategies, such as itemizing deductions, donating large amounts to charities, bunching expenses, claiming medical expenses that exceed 7.5% of adjusted gross income and earning tax breaks for buying an electric vehicle or installing solar panels, do not apply. These strategies can all help reduce your tax rate on Roth IRA conversions, or in general, but they do not reduce MAGI. Therefore, they do not impact or reduce IRMAA.

We’re in tax season. Being aware of how IRMAA works may save you some money — or, you can just impress your friends at your next neighborhood gathering.