When Medicare recipients earn more than $97,000 a year, they have to pay extra for the program. It’s known as the income-related monthly adjustment amount (or IRMAA) and it’s similar to certain phaseouts and limits for federal tax breaks and deductions for high earners. These adjustments are sometimes called a progressive tax on the wealthy. Do high-net-worth clients agree?
Bruce Primeau, a CPA and president of Summit Wealth Advocates in Prior Lake, Minn., says it irks clients when they feel they have to pay more than others for the same benefit. “It’s a system that they’ve paid more into than most folks for their entire lives and now, when they need it in retirement, they have to pay more for it than other folks. Seems about as unfair as it gets.”
Jennifer Storey, a principal at Homrich Berg in Atlanta, says that when she broaches the subject with clients, they mainly want to know how they can reduce their adjusted gross income so they don’t trigger the adjustment and aren’t as affected by the phaseouts and taxes.
Medicare recipients are also subject to a two-year look-back on their income so the program can determine their income adjustment. This, too, can seem unfair and cause headaches, say advisors.
“Some clients have their income determination based on a tax year where they made a lot of income and now no longer have those sources of income,” says Thomas Pontius, financial planner with Kayne Anderson Rudnick in Los Angeles. “We tell them to speak with the Social Security Administration and have them provide an estimate of their current income to use for the IRMAA income determination.”
Still, there are ways advisors can help clients dampen their tax hit.
“Tax planning becomes a very important piece of the retirement puzzle, especially to those close to the income tiers for the IRMAA premiums,” Storey says. One way a client can reduce the income for Medicare purposes is by gifting to charity using the qualified charitable distributions from their IRAs. Storey says this is a “a huge win for retirees” since it lowers the amount of their modified adjusted gross income.
Another strategy uses qualified charitable distributions, a favorite of Lawrence Pon, a CPA in Redwood City, Calif. “After age 70½, you can roll over up to $100,000 from your IRA to your favorite charity,” he says. “Most Americans do not itemize due to the high standard deduction, and with the high inflation, the 2023 standard deductions for all taxpayers have been significantly increased. Most high-net-worth clients don’t need their required minimum distributions, so it makes sense to fulfill the RMD requirement by rolling over the amount to their favorite charities.”
In 2019, Congress passed the Setting Every Community Up For Retirement Act. Its sequel, the 2022 legislation known as “SECURE 2.0,” has offered some solutions to those who want to head off Medicare income-adjustment woes. The new law allows up to $50,000 to be rolled over from an IRA to a charitable remainder trust, or CRT. Pon says $50,000 is too small an amount for such a complex trust structure. However, the law also allows similar rollovers to a charitable gift annuity, and he says this move makes more sense, since these annuities are “offered by most major charities [and] will pay a distribution for the rest of the donor’s life. At their death, whatever amount is left in the annuity goes to the charity.”
Income-based tax breaks could become news for the wealthy in three years: Several provisions of 2017’s Tax Cuts and Jobs Act could sunset at the end of 2025; that would result in a lower threshold for the estate tax exemption and a higher top marginal tax rate, among other potential changes.
However, some items in the law might not be missed when they go away, including the cap on state and local tax deductions.
“The state and local tax [SALT] deduction cap at $10,000 is a big source of frustration for taxpayers,” Storey says, “especially those living in high income-tax states.”
Another source of frustration for wealthy clients, specifically in high-income tax brackets, is the 20% capital gain and dividend tax for individuals earning more than $492,300 (or couples earning more than $553,850). “If you expect your income to be low in the years before 2026,” she says, “there may be opportunities to accelerate income at lower rates,” which means clients might want to look at “Roth conversions, exercising and selling stock options or restricted stock options,” among other things.
“A surprise that many wealthy taxpayers won’t be expecting is potentially being subject to the alternative minimum tax again,” Pontius says. Under the Tax Cuts and Jobs Act, high earners still had to pay the alternative minimum tax, but married couples got an exemption up to $1,036,800 in income. That threshold is set to decline again. Before the law passed, the exemption phased out at a much lower $160,900 in income.
“I’m not sure I’d call it ‘anger,’ as these individuals have likely hit the wall in the past with not receiving a deduction or credit based on their income,” Pontius adds, “but I often hear, ‘I make too much money, don’t I?’ My answer is, ‘It’s a good problem to have.’”