Managing Medicare changes, stealth taxes and self-preservation
by David G. Freitag, CLU, ChFC, CRPCMr. Freitag is a Financial Planning Consultant with Massachusetts Mutual Life Insurance Company.
In the Fall of each year, the Social Security Administration always announces a number of changes to Social Security and Medicare systems for the following year. Without Congressional intervention or legislative adjustment, these changes will happen again in 2020 and beyond. This past year the big announcement was the 2.8% cost of living increase to Social Security payments in 2019. It was welcome news to Social Security recipients because it was the largest increase to Social Security payments in the past seven years. Another piece of news in 2019 was the increase to the maximum full retirement age benefit. This year there was a $73 a month increase in benefits lifting them to $2,861 a month.
However, in 2019, along with this good news, other changes representing small tax increases or benefit reductions were also announced along with the COLA and monthly benefit increases. The first change was a tax increase caused by the upward lift of the Social Security wage base. In 2018, the wage base was $128,400. In 2019, the wage base increased to $132,900. For higher income workers this wage base increase is actually a tax increase of $344.25 for the worker and $344.25 of the employer of that worker. Self-employed workers pay both sides of this FICA tax increase.
The second tax increase is the cost to earn a Social Security credit. The new income requirement to earn a Social Security credit is $1,360. This is an increase of $40 per credit from 2018. You can earn only four credits in a year so this increase capped out at $160.
The Definition Of Retirement
The third increase is the definition of full retirement age. If you were born between 1955 and 1960, the definition of full retirement age is gradually increasing from 66 to 67. The reality is that this increase in full retirement age represents a benefit reduction for people taking benefits before their full retirement age. For people born in 1957, as an example, their full retirement age is 66 years and 6 months. A full retirement age of 66 and 6 months reduces benefits taken at age 62 by 27.5%. If your full retirement age is 66 the benefit reduction is only 25%. Remember that these benefit reductions will last for a lifetime.
The even more subtle change in benefits is the lack of COLA indexing to Social Security income tax brackets by the IRS. In 2019, for singles with “combined” income of $34,000 or married couples with “combined” income of $44,000 the brackets remain unchanged. With little fanfare or public awareness, because the tax brackets are not indexed for inflation, in 2019, more people will pay more income tax on their Social Security benefits. This no change in brackets is actually a significant stealth tax on higher income beneficiaries that receives little if any public attention.
On the Medicare side of the changes in 2019 is the new addition of higher Part B premiums for high-income people. The number of “means testing” brackets increased from 5 to 6. The top means test bracket for Medicare Part B is now $460.50 a month. In a similar fashion, the means testing for Medicare Part D at high income levels tops out at a surcharge of $77.40. Just as a reminder, this Part D surcharge is paid on top of the plan provider premium. The Medicare means testing increases for 2019 are based on income received in 2017. In 2020, the new premiums will be based on income reported in 2018. The Government calls these adjustments IRMAA. This is short for Income Related Monthly Adjustment Amounts.
It is important for financial professionals and their clients to be aware of how these built-in “on autopilot” changes to the Social Security, and Medicare programs will have on their net retirement income. As an example from a planning perspective, consider this case fact pattern:
- Bob, age 66, is working full time in his consulting practice. His earned income is $175,000.
- Bob is paying a means tested $189.60 a month for Medicare Part B and $50.20 for Part D, which includes the part D surcharge.
- Without thinking about the longer-term impact of this decision, in 2018, Bob took a $50,000 withdrawal from his IRA in 2018 for some home remodeling charges and pay for a gala 50th wedding anniversary cruise. This IRA withdraw is reported at taxable income in 2018.
- Looking forward to 2020, because of the large IRA withdrawal in 2018, Bob will now see his Medicare Part B premiums increase from $189.90 a month to about $270.90. The part D premium surcharge will be $31.90. Note that these premiums are estimated based on 2019 numbers and adjusted each year.
- Bob plans to semi-retire in 2020 and work part time. As a result, his earned income will fall to $75,000.
In this example, Bob is now looking at a large reduction in income because of his shift to part- time status. At the very same time, the cost of Medicare has increased by $112.90 a month. Of course, these increases also apply to his wife’s premiums as well. The household income for health insurance is now $225.80 a month more for the all of 2020.
In addition, because Bob was over the Social Security wage base, he will pay more FICA taxes in 2019 than he did in 2018.
Look Both Ways
From a self-preservation perspective, once you start collecting Social Security and have enrolled in Medicare, just like crossing the street, you have to look both ways. You have to look at past income and consider what impact the annual changes in Social Security and Medicare will have on next year’s net spendable income. It is easy to be blind-sided by these “IRMAA” premium increases and Social Security changes.
Also, some advanced thought must be given to RMD’s at 70 ½. If the client’s retirement savings for the most part are in qualified accounts, the required minimum distributions can automatically increase the costs of Medicare Part B and Part D. Plus, these same RMD’s can automatically cause an increase in the amount of income tax paid on Social Security benefits.
Income planning in retirement is complex and contains many different parts. These parts are interconnected just like gears in a transmission. When you turn one gear, you can have an impact on another gear and that will have an impact on yet another gear. It takes planning and awareness of how the system works to achieve success. Most clients cannot do it alone without some help and advice. ◊