IRMAA: Resistance Is Futile (But There Are Some Choices)

IRMAA Basics

Technically, IRMAA is not a tax, but a withdrawal of subsidy. The Federal government expects to subsidize 75% of the total national cost of Medicare B and D coverage. To meet that standard, the dollar amount individuals pay for Medicare is adjusted each year. The retiree not subject to IRMAA pays only 25% of the total cost of Medicare B and D, which in 2025 has been set at $185 per month for Medicare B. This amount increases each year roughly with health care inflation.

IRMAA was conceived as a cost-sharing measure under which more affluent retirees would shoulder a higher proportion of the total cost of their Medicare benefit, with burden sharing capped at 85%.

The fateful choice in IRMAA program design was to step up the retiree’s share from 25% to 85% in discrete increments, jumping the cost-sharing burden as each threshold is crossed, along with the decision to set these thresholds independent of the income tax brackets, both as to dollar threshold and in terms of bracket width. In addition, program designers chose not to withdraw the subsidy in constant increments, nor to make the IRMAA brackets all the same width.

The first (#1) IRMAA threshold is currently set about two-thirds of the way through the 22% income tax bracket, and its charge withdraws 10% of the subsidy, leaving the retiree on the hook for 35% of program costs. The IRMAA #2, #3, and #4 thresholds all fall within the 24% tax bracket, and each withdraws 15% more of the subsidy. However, the IRMAA threshold #5 is not reached until the current 35% income tax bracket (37% for MFJ), and it withdraws 5% of the subsidy, bringing the retiree up to the cap of 85%. In terms of bracket width, for singles IRMAA #1 is currently $27,000 wide, IRMAA #2 and #3 are $34,000 & $33,000 wide, and IRMAA # 4 is $384,000 wide.

Did you follow all that? The complexity is diabolical: Uneven withdrawal of subsidy across uneven dollar intervals and partially dislocated relative to income tax brackets.

What a mess.

Digging Deeper

IRMAA gets even worse when you probe further. Arranged your affairs to have substantial tax-free income from municipal bonds? Silly you. The Modified Adjusted Gross Income calculation for IRMAA adds back this income. You thought investing your emergency fund into municipals would produce tax-free income; instead, that $1,000 of “tax-free” interest could trigger $1,052 (single) of unexpected IRMAA payments.

To add more opacity, no one knows what the IRMAA threshold for 2025 is. It won’t be declared until Fall 2026. Today’s published thresholds apply to 2023. Have fun planning!

Worst of all, IRMAA is a cliff-edge tax. An income of $106,001 will trigger the entire withdrawal of subsidy, making the marginal tax rate on that one inadvertent dollar of income over 100,000 percent. Truly a Satanic tax rate!

If you are already 63 and expect future RMDs will throw you into the IRMAA zone, there are only three actions you can take. One of them is futile, one is of modest benefit, and one approaches a consolation prize.

Roth Conversions: Futile

The fundamental rule for Roth conversions is to proceed only if the conversion can be done at a lower tax rate than will apply to later distributions. Otherwise, the conversion is likely to cost money rather than save money.

In that vein, retirees are often told that the mid- to late-60s can be a sweet spot for Roth conversions. Wage income has stopped, Social Security has been deferred, and retirees may find themselves in a low tax bracket unseen since their youth.

Except, being over 62, if they convert too much they will trigger IRMAA today. Moreover, if they are under 63, they are not in the sweet spot, because they are likely still working and paying income tax at that rate.

Consider a 67-year-old just entering the sweet spot. RMDs will begin in six years in 2031. Are they at risk of IRMAA? And how could they tell?

1. First, they need to project the current IRMAA thresholds, which apply to 2023, forward for eight years.
2. Next, project their 401(k) balance forward six years.
3. Divide that balance by 26.5 (the divisor for age 73) to get their first RMD.
4. Add their projected Social Security and other income to the RMD and compare to the IRMAA threshold guesstimated in step #1.

Hey, it’s not that hard in a spreadsheet. Just make up numbers for future inflation, which will give the IRMAA threshold and the Social Security payment, and then make up a number for how much your portfolio will grow, which will give the RMD amount.

And remember: If you come in one dollar under that guesstimated IRMAA, you won’t owe a dime; if one dollar over, you owe the entire payment.

Obviously, there is no way you can estimate your 2031 income to the dollar. Sure, if it appears you will be $15,000 to $20,000, or more, beneath the IRMAA guesstimate, then maybe you don’t have to worry about IRMAA.

But perhaps your first projection shows you to be $10,000 into the IRMAA zone. At that point someone may suggest a Roth conversion today to get out from under that IRMAA payment.

How big a conversion will you need to cut your 2031 RMD by $10,000? Well, it’s obvious: you need to convert the present value of $265,000, using your projected portfolio appreciation from 2025 to 2031 as the PV discount rate. Which you don’t know.

But how much can you convert today without triggering an IRMAA today? That’s easy: just increment the current IRMAA threshold of $106,000 by the next two years of adjustments. Which you also don’t know.

Fine, then. Simply convert $106,000, which should be safe in 2025. But first, subtract whatever income you are using to pay for housing and buy food. It’s not like Roth conversions lift you onto the astral plane, removing all living expenses.

Nevertheless, every $26,500 you convert now — assuming zero appreciation on the portfolio — will reduce your 2031 RMD by at least $1,000.

Might take a lot of conversions, in the space left by the subtracted living expenses, to get you out of the IRMAA zone in 2031!

If you convert past today’s threshold, you’ll incur one IRMAA today to save one later IRMAA, violating the fundamental rule of Roth conversions by not incurring a tax benefit. And if you blow past several IRMAA thresholds today, you’ll be well into the 24% income tax bracket, with no assurance that paying IRMAA #1, #2, and #3 today will save even one IRMAA in 2031 — perhaps because your portfolio appreciation surprised on the upside, negating your efforts.

I ran the numbers for you here. Resistance is futile.

The next piece of advice will help to minimize the burden should you indeed fall into the IRMAA zone in some future year.

Managing Cliff-Edge Taxation

If the marginal tax rate is 100,000% on the first dollar past the IRMAA cliff edge, then it’s only 50,000% on two dollars in, 100% on $1,000 dollars, and but 10% once $10,000 into the zone. Again, the first IRMAA zone is $27,000 wide for a single, the second is $34,000.

You can minimize the IRMAA dollar hit, expressed as a percentage of income (i.e., tax rate), by voluntarily withdrawing money up to just below the next IRMAA boundary. The IRMAA “tax rate” will top out just below +5% on top of the applicable income tax rate, 22% or 24%. That’s way better than 100,000%.

If truly surplus, put the extra withdrawal into a total stock fund in your taxable account paying 1.00% in qualified dividends, then hold for the step up in basis at death. Or use the extra withdrawal to rent a beach villa and fly in the kids, their spouses and the grandchildren. Just saying.

Yeah, it stinks to have to pay a marginal rate of 27% or 29% when the published rate is 22% and 24%. Complain to your Congressperson. See if you can find an elected official who cares about the travails of the small slice of the senior electorate that falls in the 90th to 97th percentile of income. Too poor to cut you a big check. Too few to swing the vote. But enough juice to be worth the squeeze.

I told you: A devil who hated affluent professionals designed this tax.

Impetus to Charity

I don’t know about you, but as my marginal income tax rate rises toward 100%, I become more and more charitably inclined.

My point: The lemon of a cliff-edge tax can be turned into the lemonade of a charitable contribution that costs very little in lost consumption. Recall that straying one dollar into the first IRMAA zone costs the single about $1,052 in lost subsidy. Each dollar into the zone also costs them income tax at 22%. If one looked to be about $1,348 into the IRMAA zone for the year, and were to redirect $1,349 of that year’s RMD into a Qualified Charitable Donation, that would save income tax of about $300 and avert the IRMAA payment of $1,052. That QCD costs you almost nothing, but the charity still gets $1,349, which is not nothing.

The numbers look even better for a married couple broaching the second IRMAA zone at $266,000, where going one dollar over the cliff edge will cost them about $3,200.* Let’s also put them in California, where their combined marginal income tax rate on RMDs will be 24% + 9.3%, or 33.3%. Dividing $3,200 by (1 – tax) gives us $4,775. That is the amount where a QCD costs effectively nothing.

Personally, I don’t require deductibility to reach 100% in order to motivate a gift I was considering in any case. As deductibility marches north of 50%, my ears perk up. Take the first result for the California couple and raise it to $10,000. That QCD will save $3,300 in income tax and $3,200 in IRMAA, for an out-of-pocket cost of only $3,500, equivalent to deductibility of 65%.

Few charities will turn up their nose at $10,000.

Summary

You have three options for dealing with IRMAA triggered by RMDs:

1. Resist, using a complicated, rickety, fallible strategy of Roth conversions that could fail miserably;
2. Take a grin-and-bear-it approach, lowering the IRMAA rate by drawing down your tax-deferred balances a bit more rapidly, which will also lower future RMDs;
3. Turbocharge your charitable giving.

The choice is yours.

*Remember, more subsidy is withdrawn in IRMAA zone #2 than #1.

Edward F. McQuarrie, Ph.D., is professor emeritus at Santa Clara University. He writes about financial history and its implications for retirement planning. Working papers describing his research can be downloaded here.

A message from Advisor Perspectives and VettaFi: Discover something new! Click here to register for our upcoming webcasts.

Read more articles by Edward McQuarrie