There’s a scene in the TV show Friends where Rachel gets her very first paycheck as a waitress at Central Perk.

“Who is FICA and why is he getting all my money?” she poses to the gang.

Some people age 65 and older might have a similar sentiment when they get their Social Security check and see a chunk missing that’s gone to IRMAA.

“Who is IRMAA and why is she getting some of my money?” you might ask.

IRMAA is your income-related monthly adjustment amount, which you pay on top of both your Medicare Part B (medical coverage) and Part D premiums (prescription coverage).

We’re going to get into the subject of IRMAA in this article, as well as give you some pertinent background information necessary to understand it. We’re also going to offer you some planning tips and common mistakes to avoid.

What Is IRMAA?

When we set up retirement plans for clients, oftentimes we’ll send them a worksheet and ask them to work through and itemize all their monthly expenses. Typically, when we do this with somebody who is about to retire, they’ll list their dining-out trips, their Netflix and other streaming subscriptions, but they’ll forget their health insurance costs.

Many people have the misconception that all Medicare is free because they’ve paid into it all their working lives. We have to tell them that’s only partially correct. You may be getting your Medicare Part A for free, but you must pay for your Medicare Part B (medical coverage) and Medicare Part D (prescription coverage) and, based on your income, your income-related monthly adjustment amount for both Part B and Part D. IRMAA is an extra surtax you pay based on your income.

I was working on a financial plan the other day for clients who are high net worth individuals. Because of their current income and projected income, we had to add an extra $400 per person per month for IRMAA to their budget.

This created some discussion. The clients thought they were good with a $6,000 per month budget. But then we added on this IRMAA piece, which is essentially an additional $9,600 per year ($800 per month) – an amount that could’ve gone to a travel fund or annual gifts to family members.

According to Medicare.gov, Medicare Part B premiums (which already include IRMAA) for 2021, plus Part D IRMAA surcharges based on income from 2019, are as follows:

• Monthly premium of $207.90 + $12.30 IRMAA per person for single filers making between $88,000 and $111,000, and for married filing jointly filers who made between $176,000 and $222,000.
• Monthly premium of $297.00 + $31.80 IRMAA per person for single filers making between $111,000 and $138,000, and married filing jointly filers who make between $222,000 and $276,000.
• Monthly premium of $386.10 + $51.20 IRMAA per person for single filers making between $138,000 to $165,000, and married filing jointly making between $276,000 and $330,000.
• Monthly charge of $475.20 + $70.70 IRMAA per person for single filers making between $165,000 and $500,000, married filing jointly making between $330,000 and $750,000, and married filing separately making between $88,000 and $412,000.
• Monthly charge of $504.90 + $77.10 IRMAA per person for single filers making $500,000 and above, married filing jointly making $750,000 or above, and married filing separately making $412,000 or above.

Laying the Groundwork and Planning Tips

To give you a more robust picture of IRMAA, let’s examine some things that might impact the amount you will owe.

Right now, Roth conversions are in the news because people are concerned about impending tax hikes. Roth conversions bump up your adjusted gross income (AGI), and that will impact your IRMAA.

Many clients come to us thinking they are diversified from an investment standpoint – however, they might not have thought about tax diversification.

If you look at the tax triangle, on one side are tax-deferred accounts like 401(k)s and IRAs, which are typically the easiest ways to save. On another side, you have taxable money, like brokerage accounts – clients will typically start building those up after they’ve built up some of those tax-deferred buckets. On the third side, you have the tax-free bucket, which includes Roth IRAs, Roth 401(k)s and the like. Under the current rules, you won’t have to pay taxes when you pull money out from the third side of the triangle.

Many clients find themselves overweighted in tax-deferred money. Regardless of whether somebody is retiring with $500,000 or $5 million, I have yet to see a client retirement picture that has more tax-free money than tax-deferred money.

This is relevant to the IRMAA conversation because movement of money among these three sides of the triangle – as well as pulling money from any of them – has implications on your modified adjusted gross income used to determine how much you pay in IRMAA.

For example, because a Roth conversion moves money from a tax-deferred vehicle to a tax-free vehicle, it’s seen as income reported on your 1099-R. When your income is bumped up, your adjusted gross income and your modified adjusted gross income also bump up, which is what IRMAA is tied to.

IRMAA looks back two years in arrears. In other words, your 2022 coverage will be based on your 2020 income. So the time to start planning for it is at age 63, two years before you have to enroll in Medicare. If you’re thinking of Roth conversions now, it may impact your IRMAA two years down the road.

Avoid Common Mistakes with IRMAA Planning

There are three common mistakes you might make when it comes to IRMAA planning. Be sure to steer clear of these:

Not factoring it into your retirement budget. It’s easy to skip over how much your health insurance is going to cost. IRMAA is a significant addition to your monthly budget. It can potentially add up to $1,000 per month, in addition to what you’re already planning. If you’re on a fixed income, this could make a big difference – especially if you’re in a higher income bracket during retirement. Making sure you account for IRMAA in your retirement roadmap and monthly expenses is important.

Not realizing how much income you’ll have in retirement. I have had some clients who make more in retirement than they did while they were working. However, the sources of their income are fixed, so they don’t have the ability to decrease them – like pension, Social Security or required minimum withdrawals from tax-deferred accounts, which increase every year.

Many clients realize that they’ve done well and saved up, which leads to their income going up in retirement – but also has an adverse consequence on their IRMAA adjustment.

Not having a plan for where you’re pulling income from. Pulling $200,000 from cash vs. pulling $200,000 from an IRA has very different tax consequences that could impact IRMAA adjustments.

In your working years, you get used to getting a paycheck and knowing where your income is coming from. But in retirement, you have to create your own income by turning assets into income. This could get a little confusing. It’s important to consult a professional so that you can plan.

If you need some guidance specific to your own situation, call your financial professional.

This piece is not intended to provide specific legal, tax, or other professional advice. For a comprehensive review of your personal situation, always consult with a tax or legal advisor.

Converting from a traditional IRA to a Roth IRA is a taxable event.