Blowing out 65 candles has traditionally been a liberating milestone for Americans.
Not too long back it marked the traditional retirement age at which Social Security could be collected with no reduction and a job could be left behind without worries of qualifying for private health care. Our full retirement age has ticked up to 66 on its way to 67 for those born in 1960 and after. This shift is well known. The shock that’s hitting newly minted seniors these days is that for some the escape from employer-sponsored health insurance to Medicare can feel like jumping from the frying pan into the fire.
Medicare is thought of as a good bargain. Part pre-paid health coverage from years of working and part subsidized medical insurance. Yet for seniors the government considered high income, those defined as having $85,000 or more income per person, Medicare starts to look like not such a great deal. The premium alone will triple from $134 a month to $428 a month, per person, for those with incomes over $214,000. That’s just Part B. Throw in an average Part D premium of $48.50 in CT and the $76.20 surcharge and the monthly tab jumps to $552. And this is for a program that only covers 85 percent of a person’s expected health care costs. In addition to the expense of Part B and the drug surcharge, most people can expect to add the premium of a supplemental policy.
So what can be done?
Here are some strategies to stay out of the top five percent. The first line of defense for those already using Medicare is to appeal. The system looks back two years to the most recent tax return. Has your situation changed for the worse, or better? Sometimes a person’s income is increased by a deferred compensation plan or a monetization of unused sick days in the year of retirement.
If this is the case, appeal to a local Social Security office to get the surcharge reduced. It never hurts to ask. The Social Security Administration has published 5 reasons that categorically allow the extra premium to be waived. These include “you or your spouse stopped working or reduced your work hours,” a particularly useful one for new retirees.
Assuming you are stuck with the extra bill for at least one year, consider taking a big hit in one year to avoid smaller hits later. Call this the tear the band aid off approach.
Consider a person who earns just $100 over an income threshold of 85,000 in 2017. This $100 in extra income will kick in $642 or additional Part B premiums and $159.60 of drug-plan surcharges. The marginal tax on this $100 of income is 800 percent! If this extra income is due to a required distribution from a retirement plan, this person could convert a portion of this IRA or employer plan to a Roth IRA. This would mean taxes paid today on the amount converted. But under current law, the RMD would be avoided for future years and all earnings would be free of tax. For example, the first bracket ranges from $85,000 to $107,000 so the person could convert $21,900 of IRA into Roth IRA without further increasing Medicare. Income tax would be owed on the funds but they would not drive future income.
If it’s dividends, bond interest (tax free interest from municipal bonds counts to Medicare income), or capital gains distributions that are putting you into the taxation doghouse, evaluate what a transfer to a low-cost and flexible fixed or variable annuity would mean for your monthly budget. This can push current taxation to the future, at which time the rules, or your income, may be more favorable. In some cases, a person may have an existing cash value life insurance policy that will accept and grow additional premium tax free.
Americans in their 40s, 50s, and 60s who are looking forward to retirement will want to look to Medicare as a cautionary tale of the government punishing success and rewarding those who save and invest in the government’s tax favored plans which higher taxes later. The only defense against attacks on one kind of income is to have another. I call it the “whack a mole” defense. Like the carnival critter, we need a hole to pop out of that the government isn’t currently hitting.
Americans would be wise to take tax allocation as serious as asset allocation and forgo the tax break today of employer 401k plans for Roth accounts, non-qualified investment accounts and tax favored cash value life insurance and annuities. Each of these accounts has unique tax features that may allow a person to control taxes later in life. Under current law, money withdrawn from life insurance, for example, comes out as first in first out, or tax free basis, the best kind of income. Non-qualified accounts allow person to use losses to offset gains, which can minimize taxes in some year. Deferred annuities defer taxes until the money is withdrawn. Income annuities send a portion of earnings and a return of capital with each payment until the contribution principle is exhausted. This too can control taxes.
A caveat here is of course in order. Just as the government has repeatedly changed the rules to increase and expand taxes on the formerly untaxed, Social Security being a great example, nothing but tradition, guilt of breaking promises and good old-fashioned lobbying by interested parties will prevent it from attacking today’s tax favored vehicles. We all know life’s two unavoidables: Death and Taxes. That said, smart planning today just might avoid some of the latter in your golden years.
Mike Lynch CFP is a financial planner with the Barnum Financial Group in Shelton CT. He can be reached at mlynch@barnumfg.com or (203) 513-6032.