Carlsbad CA Estate Planning

Social Security and Medicare and the Impact on Retiree Taxes

 

“Medicare has a series of income limits that trigger increasingly higher payments for retirees. And it’s not just the rich who are affected.”

 

A 70% increase in Medicare premiums to $559 was a complete surprise to a woman who became a single taxpayer when her husband died. She felt like she was being punished for being a widow, she said in a recent article titled “Retirees, Beware These Tax Torpedoes” from Barron’s. With a 2018 modified adjusted gross income of $163,414, a combination of required minimum distributions, Social Security and her husband’s pensions, she went from being in the third-highest Medicare bracket into the second highest Medicare bracket. All it took was $414 dollars to exceed the $163,000 limit.

This is not the only tax trap awaiting unwary retirees. Lower- and middle-income taxpayers get hit by what’s commonly referred to as “tax torpedoes,” as rising income during retirement triggers new taxes. That includes Social Security income, which is taxed after reaching a certain limit. The resulting marginal tax rate—as high as 40.8%—is made worse by a Medicare surtax of 0.9% on couples with taxable income exceeding $250,000. Capital gains taxes also increase, as income rises.

There are a few steps that retirees can take to avoid or minimize these taxes for next year. The simplest one: delay spending from one year to the next and be extra careful about taking funds from after-tax accounts.

What hurts most is if you’re on the borderline of a bracket. Just one wrong move, like selling a stock or taking a distribution, puts you into the next bracket. You need to plan carefully.

One thing that won’t be a concern for 2020 taxes: required minimum distributions. While many retirees get pushed into tax traps because of taking large RMDs, the emergency legislation passed in response to the coronavirus crisis (the CARES Act) eliminated RMDs for this year.

However, the RMDs will be back in 2021, so now is a good time to start thinking about how to avoid any of the typical tax torpedoes. RMDs used to start at age 70½; the SECURE Act changed that to 72.

If you don’t need the money from an RMD in 2021, one workaround is to take it as a qualified charitable distribution. That avoids triggering higher taxes or higher future Medicare premiums. The administrator of the tax-deferred account needs to be instructed to make a donation directly to a charity.

An even better strategy: take steps long before Medicare income limits or tax torpedoes hit. If you can, live on after-tax savings, Roth IRA accounts or inherited money. Spend that money first, before tapping into tax-deferred accounts. You can then take advantage of being in a lower tax bracket to convert money from tax-deferred money to convert to Roth IRAs.

Another story of a tax hit that was avoided: a man with an income of about $80,000 prepared to take $4,000 from a tax-deferred account for a vacation. The couple’s normal top tax bracket was 12%, but they hit the income limit on Social Security taxes. The $4,000 in additional income would have caused $3,400 in Social Security income to be taxed, making his marginal tax rate 22.2% instead of 12%. With the help of a good advisor, the couple instead took $3,000 from a Roth IRA and sold a stock position for $1,000, where there were practically no capital gains generated.

Incomes at all levels can be hit by these tax and Medicare torpedoes. A skilled advisor can help protect your retirement and Social Security funds.

Reference: Barron’s (July 6, 2020) “Retirees, Beware These Tax Torpedoes”

Can You Save on Taxes in Retirement?

It's frustrating when you’ve been responsible and saved diligently for your retirement throughout your working career, but the tax bites keep on coming. Over the course of time, those accounts most likely grew substantially, observes the Citizen Times in its article “Try this strategy to save on taxes in retirement.” The growth comes from maximizing annual contributions and the power of compounding interest, which is what 20^th century genius Albert Einstein is quoted as saying is the most powerful force in the universe.

Now that you’re retired, or near to retirement, you’ll want to use tax-efficient ways to withdraw money from your investment accounts. There was a rule of thumb from the financial investment community that said just leave those tax-deferred accounts alone and use the money from your taxable accounts until you reach age 70½. You can then start taking Required Minimum Distributions, or RMDs.

Here’s the problem: that equation assumes that your income has decreased in retirement and that simply may not be true.

RMDs are taxed as ordinary income at the time of withdrawal, so they could push you into a higher federal tax bracket than you expected. Let’s say a 63-year-old married woman born in 1953 has $1 million in tax deferred accounts. An example may be taking an RMD of nearly $47,000 at the age of 70½, combining it with $47,000 from Social Security or a pension or rental property income, and you could be bumped into a higher rate tax bracket.

Another impact could be the reduction of individual income tax rates that went into effect this year, because of the Tax Cuts and Jobs Act, which expires in 2025. Those tax cuts may not be extended or may be changed, so future tax rates might go up again in 2026. When that tax cut expires, you’ll need to review your tax burden again.

So, what can you do?

If you are a retiree between 59½ and 70½, consider a Roth conversion. Proactively convert a portion of your tax-deferred accounts into a Roth IRA on an annual basis. You’ll have to pay federal income tax on the amount you convert every year. However, you’re taking advantage of lower rates before those provisions mentioned above expire and before the RMDs begin. The goal is to convert just what you need to keep you in your current tax bracket.

Be mindful that you must do this right. Work out the numbers so you don’t trigger a higher Medicare premium or the 3.8% Medicare surtax. There are a lot of moving parts. However, this could save you a huge amount in taxes. Make sure it aligns with your estate plan—check with your estate planning attorney to make sure the entire plan works.

Resource: Citizen Times (July 29, 2018) “Try this strategy to save on taxes in retirement”

Medicare Penalty Waived for Some

The federal government has always been particular about Medicare. Eligible people either sign up at the right time or they face stiff penalties, if they attempt to sign up later.

Elder law advocates have always thought that this was a harsh way to penalize many people who simply made honest mistakes and were not aware of those penalties.

Advocates' complaints have typically fallen on deaf ears, since the government was more concerned about cost controls. However, an important victory has been won for some who would otherwise face penalties for not signing up for Medicare on time.

NPR reports on this latest development in "Feds to Waive Penalties for Some Who Signed up Late for Medicare."

People who purchased their health insurance through the Affordable Care Act's marketplaces were not made aware that they needed to sign up for Medicare, when they became eligible.

When looking at the marketplace website, it appeared they were doing everything properly as long as they continued to purchase insurance on the marketplace. They have been granted a waiver of the penalties.

People affected will need to apply for the waiver. They only have until Sept. 30, 2017 to do so.

This waiver is only being granted to those who continued to purchase insurance through the Affordable Care Act, but it is an important step for many elderly people.

Reference: NPR (June 6, 2017) "Feds to Waive Penalties for Some Who Signed up Late for Medicare

Massive Medicare Fraud Alleged

Every few years it seems the federal government needs to do something to fix Medicare or risk running out of available funds for the program. One attempt to fix Medicare was undertaken in the early 2000s.  It is now known as Medicare Advantage.

The program privatized parts of Medicare by turning things over to insurance companies. The idea was that insurers would do a better job of controlling costs in the program than the government.

Instead of doing that, however, a whistle-blower alleges that insurers have used the program to make billions of dollars from Medicare they are not entitled to, as The New York Times reports in "A Whistle-Blower Tells of Health Insurers Bilking Medicare."

The alleged fraud is a relatively simple one.

Insurers are said to have used the medical coding system to make patients look sicker than they really are. As a result, the insurers easily collect more money from the government than they actually should.

The government has already announced plans to sue one insurer based on these allegations and more lawsuits against other companies are expected.

It is important for the government to stop this fraud, if true, and any other Medicare fraud.

The Medicare system is yet again close to running out of funds and in need of a fix. The government cannot afford to lose billions to fraud.

Reference: New York Times (May 15, 2017) "A Whistle-Blower Tells of Health Insurers Bilking Medicare."

The Future of Medicare

It is no secret that U.S. Rep. Tom Price is not a fan of Medicare or any form of federal government health coverage. Since he has been in Congress, the legislator has sought to make drastic changes to Medicare and to reduce its funding. This has many seniors and elder law advocates rightfully worried.

If he is confirmed as the next Secretary of Health and Human Services, the future of Medicare is in doubt, as Price would be in charge of overseeing the program.

However, as NJ.com recently argued in "Make lemonade out of possible Medicare lemon," there might be an opportunity for positive changes to the program.

One thing Price might do as secretary is to end Medicare at the federal level and instead give each state a block grant to administer its own replacement program. That could leave open the possibility that individual states could seek to negotiate prescription drug prices with manufacturers, which the federal government is currently prohibited from doing.

While negotiating at the state level would not be as effective at lowering prices as it would be at the federal level, it would still be helpful and Medicare patients could see their drug prices reduced.

Reference: NJ.com (Dec. 26, 2016) "Make lemonade out of possible Medicare lemon."

Millennials Should Pay Attention to Elder Law

People of all generations tend to pay the most attention to the issues that affect them directly and immediately.

Most senior citizens do not think a lot about the cost of a college education and the availability of entry level jobs. Conversely, younger people do not think much about Social Security and Medicare. Each group has more pressing concerns that hold their attention.

However, the younger Millennial generation should pay attention to Social Security and Medicare.

Some people believe that stock markets will be bearish in the next few years.  As a result, Millennials should save 25% of their current income to make sure that their retirement nest eggs grow at the appropriate rate, according to Wealth Management in "Should Millennials Double Retirement Savings Rates?"

Many Millennials will quickly point out that due to other economic factors beyond their control, they cannot afford to save 25% of their incomes, or even the traditional 10-15%.

As a result, people in that age group will be reliant to some extent on Social Security and Medicare when they retire. Since both of those programs face impending financial problems, Millennials need to pay attention to how these programs might change.

They should not consider it just an issue for older people. It will be their issue one day.

Reference: Wealth Management (Jan. 11, 2017) "Ken Thompson's mother says she was cut out of will by late Brooklyn DA's wife."

Human Lifespan Limit Reached

Most people would consider the fact that Americans live a lot longer on average than they used to a wonderful development. Many would like to see that trend continue.

On the other hand, it cannot be denied that extended lifespans have put a strain on many of our important services for the elderly. Medical care for the elderly can be very expensive and that has increased the cost of Medicare.

The longer people live, the longer they collect Social Security and that safety net is under stress as a result.

From that perspective it might seem a good thing that it is unlikely humans will continue to see increasing lifespans in the future, according to a report in the Guardian "Human lifespan has hit its natural limit, research suggests."

It appears biological factors limit the human lifespan to somewhere around 115 years even when people are given the best possible healthcare. If this research holds up to scrutiny, it should assist with planning when it comes to paying for Medicare and Social Security.

Of course, there are some researchers who are looking into ways to overcome the biological obstacles and extend human life even longer. So far, they have not been successful.

Reference: Guardian (Oct. 5, 2016) "Human lifespan has hit its natural limit, research suggests."