How to minimize Medicare surcharges with life insurance and annuities

Green puzzle pieces with symbols of a money bag and question mark isolated over white, Understanding your money and savingsAdvisers may consider several retirement planning options with clients that do not create unnecessarily high Medicare surcharges

Dec 7, 2015 @ 11:48 am
By Katy Votava for InvestmentNews

If you’ve been following the recent news about Medicare you are well aware that folks with retirement incomes above a certain level pay surcharges for their Medicare Part B and D.

But did you know that those surcharges, officially known as the Income-Related Monthly Adjustment Amount (IRMAA), create higher Medicare payments without any additional health coverage benefits? The good news is that advisers have several options to consider with your clients when planning for retirement income that does not create unnecessarily high Medicare surcharges.

As a refresher, the Medicare IRMAA is determined by which income tier a Medicare beneficiary is in based on the Medicare Modified Adjusted Gross Income (MAGI) sliding scale. MAGI is calculated by using two numbers from the IRS 1040 long form. Social Security uses the tax return from two years in arears from the current year. Here is the formula: MAGI = Adjusted Gross Income (AGI line 37) + Tax-Exempt Interest income (line 8b). If the MAGI is more than $85,000 per individual or $170,000 per couple, clients will pay more for Medicare Parts B and D based on a five-tier MAGI cliff bracket hierarchy. Having even $1 over into the next MAGI tier put people in the next-higher IRMAA bracket resulting in substantial out-of-pocket cost increases.


The fact is that retirement income can be structured to maximize cash-flow sources that will not be included in Medicare’s MAGI calculation. The lower the MAGI bracket, the lower Medicare Parts B and D surcharges will be without reducing benefits. In fact, those surcharges can be eliminated in the lowest MAGI tier.

Jamie Hopkins, professor of retirement at The American College, says that certain types of life insurance and annuities can provide tax-free retirement cash flow that can produce a lower MAGI and, therefore, help reduce Medicare surcharges. Here is Mr. Hopkins’ guidance on the types of life insurance and annuities that are suitable for this purpose:

• Permanent life insurance products that are adequately funded and are non-modified endowment contracts offer both tax-advantaged savings in the form of cash value and insurance for life. Cash values build up in the policy and are not taxed upon withdrawal. The policy issuer can provide information on the taxation of withdrawals from a policy.

• Immediate annuities that begin payments within 12 months of purchase can provide tax-free cash flow given that a portion of the annuity payments is a return of basis. The annuity payouts have both taxable and non-taxable components. The annuity producer provides an illustration of the breakdown of taxable and non-taxable cash flow.


Mr. Hopkins says deferred annuities offer additional tax challenges. When a deferred annuity is annuitized, the tax treatment is the same as an immediate annuity. However, when withdrawals are made from a deferred annuity before annuitization, the withdrawal is treated as taxable earnings first and not a return of basis. To make these products work successfully for your clients, Mr. Hopkins recommends that you coordinate this type of retirement income strategy with the client’s tax advisor.

Including life insurance and annuities as part of retirement income planning will be even more important going forward because the scale for setting the Medicare B and D IRMAA changes dramatically in 2016. The result of those changes is that the MAGI tier structure is becoming compressed in the upper tiers with more beneficiaries paying the top IRMAA levels. Keep in mind that the MAGI determination from the 2016 tax return will be used to set 2018 IRMAA payments.

Retirement income strategies that incorporate income and cash sources that will not flow through to the tax return as AGI or tax-exempt income are ever more important. The good news is that you can include products such as appropriate life insurance and annuities to provide that tax-free cash flow for your clients blunt the effect of the new MAGI brackets, maximize the opportunity to keep them in lowest MAGI bracket available, thereby keeping Medicare surcharges at bay.

Since 2016 is just around the corner, it is imperative to make this a priority.

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