Singles, survivors most affected by Medicare surcharges

Health care costs are a major concern for many retirees, and income-based Medicare premiums can be a shock for some, particularly because annual required minimum distributions from retirement accounts can boost their income into surcharge territory.

“Those making retirement planning decisions need to take into account an increasingly complex array of factors, ranging from the implications of the SECURE Act to managing health care costs and Medicare surcharges,” Sharon Carson, retirement strategist at J.P. Morgan Asset Management, said during a recent webcast to unveil the company’s 2020 Guide to Retirement. Financial advisers can use the helpful free report to discuss current challenges, opportunities and planning strategies with their clients.

“As the economic and legislative environment continues to evolve, those nearing retirement and their advisers now more than ever need to have a firm understanding of the various decisions that must be made in order to comfortably reach the retirement finish line,” added Katherine Roy, chief retirement strategist at J.P. Morgan Asset Management. “The guide aims to provide an objective framework to enable informed planning conversations by analyzing the most pressing issues impacting retirement.”

Ms. Carson focused her discussion on the impact of rising health care costs in retirement. She noted that total health care costs for a typical 65-year-old in 2020 will be about $5,300, including Medicare and Medigap premiums and deductibles, plus vision, dental and hearing costs that are not covered by Medicare. Over the next 30 years, those costs are expected to triple, to more than $16,000 in current dollars for a 95-year-old in 2050. 

“Given variations in health care cost inflation from year to year, it may be prudent to assume an annual health care inflation of 6%, which may require growth as well as current income from your portfolio in retirement,” the J.P. Morgan Guide to Retirement cautioned. Ms. Roy noted that annual future health care inflation estimate is a slight reduction from last year’s recommended 6.5% annual rate due to smaller increases in Medicare costs.

Many higher-income retirees are shocked at how high their monthly Medicare premiums are — well above the standard premiums — because premiums are tied to income. Medicare high-income surcharges, officially known as income-related monthly adjustment amounts or IRMAA, are based on the modified adjusted gross income reported on the most recent federal tax return. MAGI includes adjusted gross income plus any tax-exempt interest from municipal bonds — a popular investment vehicle for many retirees. In 2020, premiums are based on 2018 tax returns.

In 2020, individuals with income of $87,000 and less, and married couples with joint incomes of $174,000 and less, pay the standard Medicare premiums. But those whose incomes exceed the threshold by even $1 pay more. There are five high-income tiers that can boost annual Medicare premiums from an additional $840 per year per person to an additional $5,000 or more per year per person, virtually doubling annual Medicare costs for some retirees with very high income.

Because Medicare surcharges for singles are half that of the thresholds for married couples, survivors can be hit particularly hard by high Medicare costs following the death of a spouse, Ms. Carson noted.

For example, a married couple with joint income of $220,000 would be in the second IRMAA bracket in 2020, paying an extra $2,101 per person in annual Medicare premiums. But if one spouse died, that same $220,000 annual income would place the surviving spouse in the next-to-highest IRMAA bracket, subjecting the survivor to an additional $4,657 in extra Medicare costs.

Consequently, now could be a good time for clients to consider converting some of their assets in traditional individual retirement accounts to Roth accounts, paying income taxes on the converted amounts at current low tax rates. Individual income tax brackets, which were reduced by the Tax Cut and Jobs Act of 2017, are scheduled to expire at the end of 2025.

In addition, the SECURE Act increased the age at which individuals must begin taking required minimum distributions from 70½ to 72, giving some clients more time to convert retirement assets to a Roth before RMDs begin.

“Managing taxes over a lifetime requires a balance of your current and future tax pictures,” the 2020 Retirement Guide noted. “Make income tax diversification a priority to have more flexibility and control in retirement.”

In general, J.P. Morgan recommends contributing to a Roth accounts early in your career and shifting to tax-deferred retirement accounts as your income increases. During peak earning years, workers with substantial assets in tax-deferred accounts should contribute to a Roth 401(k), if available, because there are no income restrictions on contributions. Finally, consider Roth conversion during lower-income retirement years if future RMDs are likely to push you into a higher tax bracket.