How “means tested” Medicare could erode your Social Security benefit
by Herbert K. Daroff, J.D., CFP, AEPMr. Daroff is affiliated with Baystate Financial Planning, Boston Ma. Connect with him at
The government giveth and the government taketh away.
I will be 65 this summer and just applied for Medicare. I plan to start taking Social Security at 70. For the next few years, I will be paying my Medicare premiums out of my own pocket. When my Social Security begins, my Medicare premium will be automatically deducted from my Social Security benefit check.
In 2017, Social Security benefits increase at only 0.3%. Medicare premiums increased about 4.5%. The premiums increase even more for individuals with income over $85,000 and for couples with incomes over $170,000. The Social Security wage base increased from $118,500 to $127,200, or 7.34%.
So, more money is going toward providing Social Security benefits, but people already on Social Security already saw a decrease in their benefit. The higher your modified adjusted gross income (MAGI = adjusted gross income plus tax exempt interest income), the higher you pay for Medicare Parts B and D, thus reducing your Social Security benefit.
When countable becomes non-countable
What can you do to increase your Social Security benefits? Plan for more of your income being NON-COUNTABLE.
Just like elder care planning where there are COUNTABLE and NON-COUNTABLE assets, now, more than ever, we need to focus on COUNTABLE and NON-COUNTABLE income.
COUNTABLE income includes wages, distributions from traditional retirement accounts, and taxable (or tax exempt, including muni bond) interest, dividends, capital gains.NON-COUNTABLE income includes distributions from Roth IRAs and Roth 401(k)s, cash value from life insurance, and principal distributions from non-qualified annuities.
Therefore, the goal is to have more tax-free income. Not only does it save taxes, it also increases your Social Security income.
First, let’s look at Investment Income
Exchange traded funds (ETF) has four advantages over traditional mutual funds. Most ETFs have lower fees than most mutual funds. You can trade ETFs during the trading day instead of only at the end of the trading day. You can buy hedges, like puts, calls, stop-losses, etc. on ETFs, but not on mutual funds.
Finally, for the most part ETFs, like individual securities, are only subject to tax when you sell them, not when the mutual fund manager trades the account holdings. This last advantage can not only save taxes, but may also reduce what you pay for Medicare Parts B and D, thus allowing you to receive a larger Social Security benefit.
ETFs, like mutual funds, have an advantage over individual securities by allowing the average investor to more fully diversify their asset allocation portfolio.
Second, let’s explore Roth contributions and Roth conversions
Roth IRA contributions are also means tested. They are not available if your income exceeds specified limits. However, you can contribute to a non-deductible IRA and then convert it to a Roth IRA, since Roth conversions are not means tested. Be careful! Roth conversions from IRAs aggregate all IRAs. If you have traditional tax deductible IRAs, as well, the conversion may result in taxable income.
Roth 401(k) contributions are not means tested. Regardless of your income, you can make your 401(k) contribution to a traditional tax deductible account or an after-tax account, provided you participate in a 401(k) plan that permits Roth 401(k). If the plan permits, you can also convert your traditional Roth 401(k) to the Roth 401(k).
Consider converting portions of your traditional retirement accounts every year, up to the top of your current income tax bracket. Taxpayers who are subject to the Alternative Minimum Tax (AMT), for example, can take additional taxable income with little or no increase to their tax bill. Therefore, look at converting a portion of your traditional retirement accounts.
Life insurance death benefits on your life enable your heirs to fund a Roth conversion at your death. The life insurance reimburses the income tax on the conversion. This strategy works if you have a surviving spouse, since spousal IRA rollovers qualify for Roth conversion. If there is sufficient life insurance, the surviving spouse can not only convert your traditional retirement accounts to Roth accounts, but the surviving spouse’s own traditional retirement accounts to Roth accounts, as well. This reduces the required minimum distributions (RMD), which further reduces the premiums for Medicare Parts B and D, and therefore, increases the surviving spouse’s Social Security benefit.
If you do not have a surviving spouse, you can still use life insurance proceeds to fund the costs of a Roth conversion, if you have some warning of your death. You can convert your own retirement accounts to a Roth during lifetime. If next April, when your taxes are due, if you are alive, you can reverse the Roth conversion. If you have died, your heirs will have received the death benefits in time to pay the taxes due for the previous tax year.
If you die without a surviving spouse and without warning, your heirs cannot convert an inherited IRA to a Roth, but at least they have the life insurance to replace the income taxes and lower Social Security benefits for which they may be eligible.
Consider one more enhancement on this “Roth Conversion at Death” strategy. Your spouse could receive the life insurance, gift it to charity, and then use the tax deduction from the charitable contribution to offset some or all of the Roth conversion income.
Third, let’s look at Roth Look Alike accounts
Roth IRAs and Roth 401(k)s have after-tax contributions, that accumulate tax-deferred, and are distributed tax-free, just like 529 plans, and cash value life insurance. If the life insurance has cash value, you can use the death benefit to fund a Roth conversion at death and the cash value (NON-COUNTABLE income) during lifetime to reduce income taxes and increase your Social Security benefit, by decreasing what you need to pay for Medicare Parts B and D.
Please remember that the cash value can be in life insurance on your life, your spouse’s life, your parents’ life, or anyone else with whom you have an insurable interest. ◊