Income Targeting – Should We Even Care About IRMAA?

Walter Storholt:

Welcome to today’s episode, Income Targeting. Should We Even Care About IRMAA? Well, that’s what we’re going to talk about today with Tyler Emrick, CFP and CFA, as he reviews a recent article that suggests planning for Medicare IRMAA surcharges doesn’t move the needle. We’ll explore IRMAA, how it affects retirement income planning, and how you should account for IRMAA in your financial planning. Stay tuned and welcome to Retire Smarter.

Welcome to the show everybody. I’m Walter Storholt alongside Tyler Emrick, and looking forward to our conversation about Ole Miss IRMAA on the show today, Tyler, but no, just kidding. We’ve got a great program today. Looking forward to diving into all of that with you as we teased at the beginning of the show. But before we dive into all that, what’s going on in your world?

Tyler Emrick:

Oh, not much Walt. Doing great. Coming off a good weekend. Actually, when we were prepping for the show and catching up before, I didn’t mention this, but I got a text from my wife and have you ever heard of survival swim lessons? Have we talked about this before?

Walter Storholt:

No. Survival swim lessons. Okay.

Tyler Emrick:

Swim lessons, yeah. So my little toddler, my two-year-old, I don’t know if anybody’s ever seen it, but there’s videos online where they got these toddlers and their coursing them into the swimming pool, and then they just toss them in and they go and they turn and float. So I just got a video of my little toddler at the edge of a pool and Ms. Dez, who’s her swim teacher, actually pushing her in the pool, she tumbles over and then she rolls over and floats for about five minutes. And it is the craziest thing as a parent to see your little kid just get tossed into a pool and moved around. But I didn’t know if we had talked about that before,

Walter Storholt:

No.

Tyler Emrick:

But I’d literally just got the text this morning.

Walter Storholt:

Is there’s,

Tyler Emrick:

So that’s what’s going on.

Walter Storholt:

Training ahead of time of like, okay, when you get pushed in, you’re going to flip over or they just literally like, Hey, welcome to the pool kid, boom, you’re in there.

Tyler Emrick:

Welcome to the pool. You’re in. No. Quite a bit of training.

Walter Storholt:

Okay.

Tyler Emrick:

They’ve been doing it for a couple months now, and this was her graduating class and on the graduating class, she’s all dressed, she has to wear a hoodie, shoes, everything, and that’s the test to say, well, hey, if she was by a pool and she was walking along, she happened to slip in, survival. Right. So her being able to flip over and be able to float for a period of time and then eventually being able to get to the side.

Walter Storholt:

That’s cool.

Tyler Emrick:

So,

Walter Storholt:

That’s really cool.

Tyler Emrick:

But it’s pretty wild to see, but yeah, literally just got the text.

Walter Storholt:

Well that applies to pools or a pond or anything, right? That’s a great skill.

Tyler Emrick:

Yeah, hopefully I would think. Right. Obviously, you never know the panic factor I guess, but maybe just one additional protection there or anything we can get so.

Walter Storholt:

Well, back when we lived in a house that had a pool, I fell into it plenty of times by accident, and so I may have used some of that training on my own.

Tyler Emrick:

You’re still here so.

Walter Storholt:

Yeah.

Tyler Emrick:

I was going to say it must be all right.

Walter Storholt:

It can happen really quickly though. Not to go super serious, but this does happen every day, especially in the summer, you’re hearing stories about that. And I remember when we had our first visitors at that house where we had the pool, it was some of our friends and they had two young children, and so they came into the house and they brought in a couple of bags. We were making dinner and stuff like that, but literally, within the first minute I said, okay, so we have a pool, we have young children, so I want to just set up, we don’t have a lifeguard, so I want to set up some ground rules. Someone always needs to be with one of the children. And about five seconds later, someone went where’s so and so and we looked outside, the two kids had already snuck away and were already at the water’s edge trying to like, leaning over the pool. Literally could have fallen in right in that moment without their swimmies on. And I’m like, oh my god. Okay, so there’s my example of how,

Tyler Emrick:

Yeah. This is the point. Wow. Yes.

Walter Storholt:

So basically swimmies need to be worn at all times just in case they slip away just like that so. It happens fast so. That’s a great skill.

Tyler Emrick:

Oh, it does.

Walter Storholt:

I’m glad you guys are doing that.

Tyler Emrick:

Oh, absolutely. Full credit to my wife. Wasn’t even on my mind at all, and when she brought it up, I was like, oh, okay. I guess that makes sense so.

Walter Storholt:

Yeah. Yeah. That’s wonderful.

Tyler Emrick:

But other than that, nothing too exciting going on in the old Emrick household right now.

Walter Storholt:

Very cool. Well, I don’t know how I can tie in the survival swimming into a conversation about IRMAA and Medicare, but maybe we’ll think of it later on or you’ve got a bright idea, but yeah, what’s brought this,

Tyler Emrick:

Not that good, Walt. Not that good.

Walter Storholt:

Not that good, not that good.

Tyler Emrick:

I can talk about acronyms though. I mean, obviously, in our industry we have so many of them, and I think one of my biggest fears, right, is I’m sitting in a meeting with a new family and they bring up some acronym that I’m like, wait, what is that? Or some abbreviation.

Walter Storholt:

Have I heard of all of them before?

Tyler Emrick:

Correct. But IRMAA might fall in that boat and some of the listeners might be going, well, what the heck is this IRMAA? And what it stands for, it stands for income-related monthly adjustment amount, and it pertains to your Medicare. And what happens is the good old Social Security Administration will look back on your income from a couple years ago once you go on Medicare and if you made too much money, well you’re going to pay more or could potentially pay more for your Medicare premiums. And so it kind of serves as a means-tested method for Medicare to ensure that higher-income individuals pay higher premiums for their Medicare. Now, I think it’s probably important to give a little bit of a high level or a bit of a breakdown on Medicare. We’re not going to go into full board details. I know Kevin’s done that multiple times in the past and we’ve done a two-part series. I can’t remember the episode Walt. I think it was like 50, 58 or so we did or maybe 59.

Walter Storholt:

I’ll look it up momentarily. Yep.

Tyler Emrick:

So and where we had on Zig Novak, one of our local Medicare specialists, and he did a great job kind of breaking down some of the decision points and what you need to be thinking of with Medicare and kind of how the parts are broken down. But there are two parts,

Walter Storholt:

58 and 59.

Tyler Emrick:

58 and 59.

Walter Storholt:

You were right there.

Tyler Emrick:

Okay.

Walter Storholt:

We’ll link to those in the description of the show today. So that’s easy to find for folks.

Tyler Emrick:

Nice. But it is important for you to probably understand, well, what parts of Medicare are we talking about when we’re thinking about IRMAA and how it might impact you. And the first part as you think about Medicare is part B and that’s your doctor’s insurance. So it covers doctor’s visits, including specialists, ambulance services, vaccine, home healthcare, and a few other things. And most individuals are going to pay a monthly premium for their part B insurance. And that premium starts at $164.90 cents this year, and most people pay that right out of their social security checks. If you’re not drawing social security, then you would just pay that just as you would any other payment or any other bill. So IRMAA will affect your part B premium amount. It also will affect your part D premium amount, which is your drug insurance, which of course covers your prescriptions.

Now, prescription plans can vary by cost, but that IRMAA surcharge is a premium that is on top of that. So I’ll give you a little bit of a high level of how this IRMAA surcharge could affect those two premiums. Again, your part B and your part D. So the first threshold for IRMAA is, again, we’re looking back two years prior to when you go on Medicare or the year that you’re looking to make those Medicare premium payments. And if your income married filing jointly, if your income’s below 194K, and when I say income, I guess this is where we get down into the nitty-gritty and it can’t be very easy and just say income, right? What do we mean by income Walt, right?

Walter Storholt:

Yeah.

Tyler Emrick:

So it’s taxable income, is it AGI? And in this case, they’re actually looking at your modified adjusted gross income. So as we look at this Medicare surcharge, there are income tiers that will determine how much of a surcharge will be applied in your specific situation. And that tier for individuals or families that file married, filing jointly starts at about $194,000 of modified adjusted gross income. And if your income is above that up to the first tier, so the first tier goes from 194 all the way up to $246,000, then your part B premium could be adjusted upwards of 65, roughly $65 per month, and your part D premium just over $12 per month. And that’s per person. And then that’s just the first tier. There are five total tiers. So as you think about the monthly adjustment and how costly it could potentially be, well that part B surcharge for IRMAA could go upwards of $395 per month roughly and $76 per month for your part D.

And again, those are per person. As we think about this, it’s not something that might be in your line of sight immediately, but when you get that good ole letter from the Social Security Administration that says, Hey, we looked back at your income two years ago and you’re going to fall into one of these IRMAA tiers, instead of paying the $164.90 cents per month baseline for your part B premium, we’re going to increase it by one of these amounts and it will depend on which IRMAA tier that you actually fall into. And of course, this is one of those tiers that are a little bit more important. And the reason why I say that is because if you go over by $1, you are actually going to be hit with the surcharge. And so it’s something to where I call it like a cliff or think of it as a cliff, and if you go over it, you’re in it. So there is no do-overs. And if you go over it and you miss it Walt, it can be pretty, in my opinion, it can certainly be costly.

Walter Storholt:

A cliff is probably a pretty good way to describe that then. Yeah, once you go over it’s not like sliding down a hill where you might be able to stop it. No, you’re in trouble so.

Tyler Emrick:

You’re in it, right? Or it isn’t just what I call marginally painful. Right. You think about the,

Walter Storholt:

It’s going to hurt.

Tyler Emrick:

Income tax brackets. Right. And if you go over into, say the 22% tax bracket and you only have $1 that goes over, okay, that’s no big deal, but for this one, it’s like, Hey, if you go over it, you’re going to be paying that surcharge a couple years down the road. Now, what caught my eye, and I think you alluded it to when you set up the podcast today was that article, which was from a pretty reputable source that alluded to the fact that saying, Hey, we should really just stop and just quit worrying about IRMAA altogether. And the author’s argument was essentially that the IRMAA charge is a very small percentage of your adjusted gross income. He estimated anywhere between one and 1.5% of your adjusted gross income.

So all the work that it might take to go and say, Hey, am I going to come up on this limit and what do I need to do to avoid it? And all that work isn’t really justifying avoiding the cost because that cost really isn’t going to move the needle for most families. And kind of set me back because from my standpoint, and maybe this tell you a little bit how frugal I am, but I think the cost is extremely important to pay attention to. It might not be a huge cost, but I think for many, it can be very easy to manage the IRMAA brackets or potentially just avoid them altogether. So with some proper planning, the author made it seem like it was this big ordeal. I think it can be for the vast majority of listeners out there, something that’s fairly easy to accomplish, assuming that you do the work ahead of time.

Walter Storholt:

Yeah, sounds like, I mean, if there’s this cliff that we’re approaching and a little bit of planning helps us from going over that cliff, well then that moves the needle to me, right?

Tyler Emrick:

Sure, absolutely. And I think it first starts with, well how should you think about the IRMAA surcharge? And his suggestion from the article was think of it as a percentage of AGI. I would suggest you think of it as in a little different frame of light that will help you better make decisions on, well, do I want my income to go up into IRMAA? Is IRMAA going to be a problem for me? And as you start thinking about your income and distribution planning throughout retirement. So I would urge you to think about the IRMAA surcharge in the form of tax rates. So what do I mean by that? Well, for example, when you take a distribution from your IRA account in retirement, you or your advisor is certainly going to be able to know what taxes you’re going to owe on that distribution.

And sometimes when you take an IRA distribution, that distribution would bump you up into the next tax bracket. You might go from the 12% tax bracket into the 22. And when you understand that information and the impact of that, that’s going to help you make a better decision on whether you should take that distribution or look at other options. So I would suggest thinking about IRMAA costs in the same way, and I think this might better be illustrated in a quick example. So in this example, to kind of get the baseline out of the way, think about, hey, this is for a married couple filing jointly, and both you and your spouse are on Medicare. And let’s say you’re coming to the end of the year and you’re modified adjusted gross income for the year, looks like it’s going to hit a roughly $194,000.

And if that’s the case, then you’re going to have no IRMAA charge and a couple years from now, you’re not going to have to worry about Medicare surcharges, but you’re watching TV and a perfect commercial comes across and it’s this new car and you’re like, you know what? I really need that new car. Right. So you want to get a new car before the end of the year. So you go and you’re thinking about taking that money and taking a distribution from your IRA account, your pre-tax retirement account. Let’s say you need $52,000 to purchase that car. So now with this IRA distribution, your income is now going to go above that first IRMAA tier and you are going to have to pay an IRMAA surcharge two years down the road. Now when I look at that $52,000 IRA distribution, I think most families will look at it from the perspective of, well, you’re pulling that money out of your retirement account.

Good old Uncle Sam’s going to get their hands on a little piece of it, right, in the form of income taxes. When we think about the Medicare IRMAA charges, two years from now, since you are now going to go into that second IRMAA or that first IRMAA tier, you’re going to pay, you and your spouse roughly $1,900 more in Medicare part B and D premiums two years down the road, specifically it’s 1,875 bucks. Okay. So if you simply take that future charge in IRMAA, the $1,875 and divide it by the distribution of 52K, you’re going to come up with a percentage, 3.61% roughly. So we can take that percentage, I think is extremely helpful, because we can take that percentage and add it to your income tax bracket that you’re going to have to pay, and that’ll give you a full picture of the actual costs of making that distribution. And you can use that number and compare it to maybe your future tax rates down the road to get an idea of, Hey, is this still a reasonable cost for the distribution? Does that make sense Walt? Are you following me so far?

Walter Storholt:

It does, yeah.

Tyler Emrick:

Okay. And what I think is even more helpful as we kind of wrap our arms around thinking about it this way is it’s very important to realize again that IRMAA tiers $1 over, remember a cliff, at $1 over, you are going to be into that tier. So if we change our scenario up just a little bit, and let’s say for that car you don’t need $52,000, you need half that. So let’s say the distribution then would be $26,000. Well, if we run our same math on a $26,000 distribution, the $1,875 IRMAA charge is not going to change. Right. Because we’re in that tier.

So we use our math, we divide the 1,875 charge by now a $26,000 distribution and your tax equivalent, or the way we could think about that, it almost doubles. So the cost jumps up to about 7%. So if we add 7% now to your ordinary income rate, you could see how that looks like the withdrawal’s costing you a bit more, right, because the IRMAA charge doesn’t change and you’re getting less out of your IRA account. Now, prudent planning might suggest that, or you might want to ask yourself in a situation like this and say, Hey, does it make sense for me to maybe fill up that first IRMAA tier and take my income up and do a $52,000 distribution even though I don’t need that full amount, I only need 26 for the car and maybe do a Roth conversion or pull it out because again, that IRMAA charge is not going to change.

Walter Storholt:

So you’re saying either avoid the cliff or if you’re going to go over the cliff, send it.

Tyler Emrick:

Yeah, potentially go all the way. Right. And there could be some other factors, but you got it.

Walter Storholt:

Evel Knievel it. Jump over the cliff.

Tyler Emrick:

Go in, right? Well, and as you think about it, if we go as how the author has suggested and said, quit worrying about IRMAA altogether, well under his advice, what we would do is just do the $26,000 distribution for the car and call it a day. But you could see how, all right if I’m already going to be in that tier, it might make sense to just go ahead and fill it up, Evel Knievel it as you say, to fully take advantage of, Hey, I’m going to be in there already, my costs aren’t going to change. Now there are other factors. Right. Obviously, you’re going to have to pay ordinary income tax and all that other good stuff on the distribution, so you want to be mindful of that, but forgetting about the tiers altogether, I think we lose sight of how valuable they can be from an income planning standpoint.

Walter Storholt:

Very cool. So it sounds like yes, the answer is incorporate this into your planning.

Tyler Emrick:

Sure. Yeah, absolutely. And I think it does show up in different forms depending on your specific situation. I think every family that we work with here at True Wealth Design when we’re walking through income targeting and income and distribution planning for our retirees, IRMAA is going to be a factor. But the question is, how much of a factor is it going to play? So I think maybe walking you through a couple client scenarios to kind of show how it shows up in each of those scenarios might be helpful,

Walter Storholt:

Love it.

Tyler Emrick:

As we think about this. So you think about the first family here or the first scenario, and this is a family that, all right, let’s say they’ve done a very, very good job saving, but most of their savings have been through their employer retirement plans or individual retirement accounts, as with a lot of families that we work with. So they have the bulk of their retirement assets in pre-tax retirement accounts, and once you come to retirement, that is great that you did the savings, but of course that poses some issues or potentially could have some concerns for that family. The first one would be good old required minimum distributions or RMDs. Now once those come down the line, if you have most of your assets in pre-tax retirement accounts, you might be surprised on how much that RMD distribution is going to be and that might down the road kick you into a higher tax bracket or cause some other tax issues kicking you into an IRMAA tier if you don’t appropriately plan for it.

Another scenario for that family is potentially leaving a legacy. I don’t know if any of our listeners have ever inherited accounts from a loved one or a family member and they inherited pre-tax retirement accounts, but when you do inherit those assets, the good old IRS wants their tax money on that Walt. So they’ve got rules that you need to follow depending on how you inherited it, and those rules might require you to do distributions. And of course those distributions are taxable.

So if you have this huge pot of money that you’ve never paid taxes on and you’re doing some estate planning, you got to be mindful of, or some families want to be mindful of, well how is that tax burden going to fall through to the family members that are going to inherit this money long-term? So as we think about their income planning, IRMAA can be a very big piece of that equation because if most of your assets are in pre-tax retirement accounts, well it becomes easy for us to get very precise on our income targeting each year and take you right up to those limits because we don’t want to go over. Or if we do want to go over going ahead and filling up one of the IRMAA tiers and going to the top to avoid increasing that IRMAA charge down the road.

So we can do that very tightly and there’s no issues around us doing that because we can be very specific on the amount of distributions that we take out of those pre-tax retirement accounts. And this all goes into a factor of it’s important to understand, hey, you need money to live and you want to spend retirement the way that you want. And you’ve got to cover those base needs, but a lot of times you might want to take out more than what you need from a spending standpoint out of those retirement accounts, get the taxes out of the way through Roth conversions and the like and go ahead and do some of this income planning for IRMAA down the road when RMDs hit or for estate planning down the road when individuals inherit it.

Walter Storholt:

Tyler, it’s been great information, definitely feel like I learned multiple things on today’s show and my biggest takeaway really is I’m kind of blown away that this is the level of detail that you guys get into your planning at True Wealth Design. I just can’t imagine that every financial advisor out there is doing this level of detail of planning for their clients. So I’m continually, every time we do this show blown away by just how in-depth you guys go with your clients and the people that you work with.

Tyler Emrick:

Appreciate it. Well, I think it’s important and maybe part of that might just be being frugal, but understanding how these are going to impact your situation. If there’s opportunity for us to better manage it and provide better outcomes, well hey, that’s more money for your retirement, that’s more estate assets that are going to be passed down to your heirs and it just puts you in a better financial situation overall. Now, not every family out there is going to be in that situation though, Walt where, hey, all the bulk of my savings are in these pre-tax retirement accounts and we can manage your income very tightly each year, right? We have a subset of families that maybe have larger assets outside of retirement accounts or maybe they have larger private investments. And under those scenarios, it does become harder for us to be very precise with our income targets, especially when it comes to IRMAA and that cliff. Right. Where if we go over it, you’re going to have to pay that charge because as anybody who’s had private investments or larger non-retirement accounts, well we got to manage capital gains distributions.

Those private investments are going to have K-1s and those K-1s are going to have income that flow through to your tax returns. And a lot of times we don’t have a lot of control over what flows through on that K-1 or what happens in that particular investment. So one year we might have a lot of write-offs in the form of losses. Other years we might have other gains that we have to deal with it. So it can add a layer of complexity that flows through down to our income targeting when we think about IRMAA.

And a lot of times for those particular families and especially for families that have accumulated significant wealth outside of retirement accounts, we might move our targets and instead of targeting for IRMAA or modified adjusted gross income targets, we might switch our target and target ordinary income. Right. Because as you think about targeting ordinary income, we have more control there and we can control what gets taxed on the return from an ordinary income standpoint and all those gains, capital gains, dividend distributions and stuff that are kicked off from these assets that are not in retirement accounts, well all that’s going to be stacked on top of that ordinary income. So we can kind of get more granular and very specific and switch those targets.

And in that case, maybe the IRMAA bracket management isn’t as impactful for those families, but we still have it in the back of our mind and we are still being very mindful on, well, hey, are you in the top tier? Are you ever going to go outside of that and how do we manage for your specific situation? Which a lot of times is going to turn more towards that estate planning, avoiding taxes and the like. So it can show up in many different ways depending on your situation. But making that comment that, hey, we should avoid IRMAA bracket management altogether because it really doesn’t move the needle, I don’t know if that’s telling the whole truth, maybe for a subset of families, but for a lot, including probably a lot of our listeners, we just don’t necessarily think that’s the case.

Walter Storholt:

I love it. Where there is a lever to be tweaked or turned or a stone to be overturned to look for an opportunity, you guys are experts at that part so.

Tyler Emrick:

Try to. Yeah.

Walter Storholt:

Love hearing the different ways that you try to squeeze out every opportunity for your clients and today’s episode seems like a great example of that to me. If you listen to today’s show and you’re kind of thinking, yeah, I need some help with my financial plan, or I wonder if I’m a good fit to work with the True Wealth Design team, if you want somebody to do this kind of planning and analysis for your financial situation and talk to you about your retirement future and all related things, give a call and have a conversation with Kevin Kroskey, with Tyler Emrick and the rest of the great staff there at True Wealth Design. The number to call is 855-TWD-Plan, (855) 893-7526. You can also go to truewealthdesign.com and click the are we right for you button. That’ll allow you to schedule a 15-minute introductory call with an experienced advisor on the team, and you’ll be able to set up that conversation and just see if you’re a good fit to work with one another and where these needles might be in your financial situation that can be moved, tweaked, and put in the right direction.

We’ll put links and that contact information in the description of today’s show so you can find it easily. As well, don’t forget to check out the previous series that Kevin did on Medicare back on episodes 58 and 59. We’ll link to those in the show notes as well. Tyler, thank you so much for taking us through all the details on the episode today. Enjoyed this one my friend, and we’ll look forward to checking in with you again in a few weeks.

Tyler Emrick:

Sounds great.

Walter Storholt:

All right. Very good. That’s Tyler Emrick. I’m Walter Storholt. Thanks for joining us today. We’ll see you next time on Retire Smarter.

Speaker 3:

Information provided is for informational purposes only and does not constitute investment, tax, or legal advice. Information is obtained from sources that are deemed to be reliable, but their accurateness and completeness cannot be guaranteed. All performance reference is historical and not an indication of future results. Benchmark indices are hypothetical and do not include any investment fees.