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When building your budget for retirement, the cost of health insurance (ie. Medicare) can easily be overlooked. While there is no crystal ball to tell us exactly what things will cost in retirement, you can prepare for your future by looking at the systems currently in place today!
In our Second Act Planning course, we directly address Medicare expenses, but we start with Tax-Efficient Income Planning. That’s because the way in which you pull income from the “three buckets” can dramatically impact your Medicare premiums. If you’ve spent any time with us in the past, you already know the three buckets:
The Tax-Deferred Bucket
The Taxable Bucket
The Never-To-Be Taxed Again Bucket
Taking strategic distributions across these three buckets can pay dividends in the form of lower insurance premiums.
Medicare Parts A and B
Although most people receive Medicare Part A coverage for free, Medicare Part B (which covers doctor and other outpatient services) comes with an annual premium. Because the federal government doesn’t know how much money you have sitting in your bank account, they use the taxable income from your tax return to determine who has enough money to pay their “fair share” of premiums. By looking at last year’s tax return the federal government determines who had higher income, and they pass on higher premiums to the higher-income tax payers. This method of determining who should pay more in premiums is called “means testing” or Income Related Monthly Adjusted Amount (IRMAA). The chart below shows the income “brackets” for additional Medicare premiums. One important note to make about Medicare premiums is that unlike tax brackets, the premium is all or nothing. With income tax, if you creep into the next tax bracket, only the income earned in the higher tax bracket is subject to higher tax. With Medicare means testing, even $1 over the limit results in you having pay the full higher premium.
Figure 1 2021 Medicare Part B monthly premiums/person based upon income
Looking at Medicare means testing through the scope of our Durable Cohesive Plan Of Action, we can quickly see the importance of creating a steady stream of taxable income, rather than having higher income taxes in certain years and creating future higher Medicare premiums. For example, a married couple filing jointly in 2019 that saw an increase in income from $175,000 to $177,000 (only a $2,000 increase) would receive an additional annual Medicare premium of $712 per person in 2021, or a total annual increase by $1,425. That’s essentially a 70% Medicare tax on just $2,000 of additional taxable income, and that doesn’t include the federal or state income taxes due.
An Unavoidable Expense
Another item that we observe people failing to factor into their financial plan is the cost of these premiums over the course of their lifetime. When someone signs up for Medicare at the age of 65, the premiums can be low, as they may not have claimed Social Security, and they may not be pulling much income from their IRA or 401(k). However, Social Security and pension income increase as people age, and this can happen while Medicare premiums are on the rise. The IRMAA brackets (see chart above) may or may not increase with time, but the cost of health care is sure to rise. Since 1970, the average annual medical expense increased by roughly 7.4%.(1)
Adding the RMDs (Required Minimum Distributions that start at the age of 72) and other sources of income that come into play, people need to proactively prepare for the cost of health care and have a clear picture of how their income will change in retirement; as the cost of health care is not likely to get better as we look into the future.
Options to Mitigate Medicare Premiums
Managing your taxable income in retirement can have a huge impact on your lifestyle. This is a harsh reminder that siloed financial planning may achieve the short-term results you desire, but at the cost of achieving your long-term financial goals.
If you have any questions regarding this process, or you have financial planning questions that you would like addressed by a CERTIFIED FINANCIAL PLANNER™, please call us or set up a no-obligation 15 minute discovery call.
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