Married couples could significantly lower their joint lifetime income taxes and may reduce their joint lifetime Medicare premiums by doing Roth conversions while both are alive, an expert on Social Security benefits issues says.
The basic idea is that couples can use Roth conversions to remove assets in tax-deferred accounts, thereby avoiding higher tax brackets and increased Social Security taxes and Medicare premiums in their later years of retirement. The key is to lower required minimum distributions from these accounts that would lead to higher marginal tax rates.
“I don’t think people understand how important this taxation of Social Security really is,” says William Reichenstein, head of research for retiree income at Social Security Solutions and an emeritus professor of finance at Baylor University.
Couples have to watch out for two things in their retirement account distributions: higher marginal tax rates and a spike in income-related Medicare premiums, Reichenstein notes. Partial Roth conversions made while both partners are still alive can blunt the effect of both.
Medicare’s income-related monthly adjustment amount, also called “IRMAA,” is what you may pay in addition to your Part B or Part D premium if your income is above a certain level. The Social Security Administration sets four income brackets, adjusting for single filers and married couples.
Reichenstein explains that the first year after the death of a spouse, a widow will face tax brackets for singles, which are higher than those for married couples filing jointly. She may pay larger Medicare premiums three calendar years after.
So if a spouse died in 2019, the widow in 2020 would be forced into the singles brackets (if she has not remarried), and her standard deduction would be decidedly lower. If the widow and the late spouse were the same age of at least 65, her adjusted gross income would likely be only slightly lower than what it was before her spouse died because she would now collect only the higher of the two Social Security benefits. In most cases, Reichenstein says, her AGI would consist primarily of required minimum distributions from tax-deferred accounts like a 401(k), the taxable amount of Social Security benefits, any interest or capital gains the couple would have gotten on assets, and pension benefits (when applicable).
Reichenstein offers an example: If both partners are alive with a modified AGI of $181,000, their 2022 taxable income would be $152,300 ($181,000 with a standard deduction of $28,700) and their federal income taxes would be $24,740. When the wife is widowed, her AGI and modified AGI would be $171,000 because she’s lost the smaller of their Social Security benefits. In this case, after deducting her standard deduction of $14,700, her 2022 taxable income would be $156,300 and her federal income taxes would be $31,347.50.
“In short, she would pay $6,607.50 more in federal income tax as a single individual than they would have jointly paid if both partners were still alive,” Reichenstein says. State income taxes make it worse.
As for the annual Medicare premiums, using the same modified AGI, both spouses, if they were alive, would each pay $170.10 per month in Medicare Part B premiums in 2022—for total annual premiums of $4,082.40 ($170.10 x 24 months). For a widow, 2022 monthly Medicare premiums would be $544.30 (the $170.10 standard premium plus $374.20 of IRMAA) for an annual Medicare premium of $6,531.60 (12 months x $544.30). For a couple, the modified AGI would be $181,000, meaning they would each pay $170.10 per month for a joint annual premium of $4,082.40. The widow’s annual Medicare premium of $6,531.60, Reichenstein notes, is $2,449.20 more than the couple’s annual joint Medicare premiums would have been if both were still alive.
But by making a partial Roth conversion while both partners are alive, he says, the couple pays 22% on additional income this year. “This strategy is better than not making the partial Roth conversion and the widow having to pay federal income taxes of 24% on the [tax deferred account] withdrawal later in life,” he says. Partial Roth conversions made while both partners are alive, meanwhile, can greatly reduce both joint lifetime Medicare premiums and the surviving spouse’s Medicare premiums three years after she’s widowed.