Medicare Part A receives its funding from a couple of sources. The first source is a payroll tax of 2.9%. The employee and the employer split the tax evenly each paying 1.45%. Beginning in 2014, the Patient Protection Affordable Care Act introduced two additional taxes for couples earning over $250,000 or single filers earning over $200,000. The first is an added .9% tax on earned income. The second is a 3.8% tax on net investment income.2 If your income is close to these levels, discuss this tax with your financial advisor and tax professional. If you are able to manage income flows, capital gains, and utilize tax favored investments to keep you below these income thresholds, the tax savings are meaningful.
Since the funding for Part A is provided by the aforementioned taxes, there is no direct cost for this insurance when one becomes eligible and enrolls. Most people are eligible and enroll in Medicare Part A when they reach age 65. The most common way to know that you are eligible for “free” Part A coverage is if you qualify for Social Security benefits. There are special considerations for those who need Part A due to a disability prior to age 65. You may wish to delay your enrollment in Part A beyond age 65 if you have creditable coverage from an employer health insurance plan. This is most common when one desires to continue funding into a Health Savings Account. This strategy will be discussed in chapter 4.
For a full description of enrollment and eligibility, visit Medicare.gov.
Medicare Part B 3
Medicare Part B, your doctor and outpatient services coverage, handles two types of services.
Medically necessary services: Services or supplies that are needed to diagnose or treat your medical condition and that meet accepted standards of medical practice.
Preventive services: Health care to prevent illness (like the flu) or detect it at an early stage, when treatment is most likely to work best.
Medicare B has a $166 (2016) annual deductible, 20% coinsurance (with no limit), and a monthly premium based on your income.3
Most people pay the Medicare Part B premium with a deduction directly from their Social Security benefit. Since Medicare is now mandatory, this reduction from your retirement income stream can be delayed but is ultimately, unavoidable. The amount of your 2016 premium is based on your 2014 income (Modified Adjusted Gross Income) meaning “higher” income earners will have a substantially higher premium (see chart below). This is referred to as an Income Related Monthly Adjustment Amount (IRMAA). To put it more plainly, it is a tax. Once again, the IRMAA tax is an extra charge added to your premium.
As the chart shows, individuals in the lowest income bracket have a Part B premium of either $1,258 or $1,461. The reason for the multiple premium levels is somewhat complex. Most Medicare enrollees (primarily those in the lowest income bracket from the chart above) were spared a 2016 16% price increase. There is legislation that provides some protection from an increase in Medicare Part B premiums in years, such as 2016, where there was no cost of living increase in one's Social Security benefit. This means that if you were enrolled in Social Security and Medicare Part B in 2015, your 2016 premium remains at the 2015 level of $1,258. If you enrolled in Medicare in 2016, and are in the lowest income bracket, you were not spared the 16% price increase and are paying $1,461. It is worth noting that those who were not enrolled in Social Security in 2015 because they were not eligible (some federal retirees for example) must pay the full $1,461 in 2016.
A 16% one-year inflation rate may seem outrageous, but the 2015 Medicare Trustee Report had initially forecast a 52% rise.4 Congress intervened with the 2015 Bipartisan Budget Act, limiting the amount of the increase.
It is important to recognize that the inflation rate on Part B premiums has averaged 7.86% since Medicare's inception in 1966.5 This is well above the 1.0% to 2.0% cost of living adjustment we are accustomed to seeing on Social Security benefits. The combination of the IRMAA tax and rising Part B premiums could result in a flat or even steadily declining Social Security benefit for some retirees. Once again, there is a piece of legislation (2009 Hold Harmless Act) that provides relief for individuals who do not earn enough to pay the IRMAA tax. For those in this category, increases in Part B premiums cannot exceed the amount of a Social Security cost of living increase. This means that part B premium increases can eliminate some or all of a Social Security pay raise, but cannot decrease the benefit.
Another important item to note is that the Social Security Administration considers your income from two years ago to determine your current Medicare premiums. If you experience a life changing event and a resulting drop in income, you may be able to lower your tax by having the administration consider your current income. In order to accomplish this, you can apply with a form (SSA-44) that is sent into the Social Security Administration. The most common acceptable reasons are loss of income due to retirement, death of a spouse, or divorce. The form is located at SocialSecurity.gov.
When examining the income levels that trigger Medicare taxation, there are important considerations. Medicare is under enormous financial strains. The 2015 trustee report forecasts insolvency by 2030 if no action is taken. The Congressional Budget Office estimates that there are close to 54 million Americans covered by Medicare, a figure that will rise to approximately 70 million people in 2030 and 80 million in 2039. Only an estimated 5% of Americans are currently paying the Medicare tax, meaning their Modified Adjusted Gross Income is above $170,000 for a couple or above $85,000 for a single filer. Our current administration has publicly stated that the number of people paying the IRMAA tax will need to increase to 20% to 25% of the population as part of a plan to keep Medicare solvent.6 More taxpayers are gradually moving into higher tax brackets, as the brackets are not indexed for inflation (and cannot be until 2020). More drastic measures, however, are probable. A bipartisan commission on health care reform has recommended that the taxation begin at income levels of $90,000 for a couple and $60,000 for singles7.
In addition to the lowering of income levels that trigger taxation, there are also factors causing taxable incomes to rise. For example, on June 1, 2016, 10,000 baby boomers will begin turning age 70-½ each day. Age 70-½ is when taxable, required minimum distributions will begin on trillions of dollars of qualified IRA, 403(b), and 401(k) assets. This means that the taxable income many individuals will receive from their qualified savings plan will push them into a higher IRMAA tax bracket. The IRMAA tax and its impact on your Social Security benefit will become a reality for many more Americans.
As you consider this grid once again, there are added, unexpected consequences that may arise. For example, when a spouse passes away, the surviving spouse will usually experience a drop in income due to lower Social Security benefits and lower pension benefits. You might logically expect this widow to find herself in a lower IRMAA tax bracket due to the lower income level. However, the resulting drop in income may be more than offset by the higher tax bracket the surviving spouse moves into due to the fact that they must now file as a single. The bottom line could actually result in an increase in Medicare cost for the surviving spouse!
Proper investment and tax planning will significantly reduce the amount of your Part B IRMAA tax. In chapter 3, I will describe strategies to use while accumulating wealth for retirement as well as ideas regarding the distribution of wealth during retirement. As with Medicare Part A, it may be prudent to delay your enrollment in Part B. We will discuss those pros and cons in chapter 4.
Summary of Medicare Parts A and B
Medicare Part A is funded during working years with a payroll tax deduction. Higher income earners have additional tax on earned income and investment income.
Medicare Part B is funded upon enrollment with a monthly premium.
Medicare Part B premiums are increased by an IRMAA tax as your Modified Adjusted Gross Income increases.
This Medicare Part B premium is deducted from your Social Security benefit.
Income