How can I act now (December 2016) to lower Medicare premiums that will be assessed in 2018?

Medicare is a cost-sharing program to cover the different elements of medical expenses for individuals age 65 and older.

Medicare Part A covers hospital visits, this part of the Medicare program is free. 

Medicare Part B covers outpatient services and involves a premium to all participants. 

Medicare Part D Prescription drug coverage and involves a premium payment.

The premium reflects the government’s estimate of program costs for the following year and is, designed to cover 25% of total expense. The other 75% is paid from other sources.   One of those sources are individuals who can afford a larger share of the cost.  Those individuals are identified through the tax return system.   

As your income increases, it is compared against a table that has 5 progressive brackets used to determine the level of premium contribution — ranging from 25% (low end) to 80% (high end). This causes higher income individuals to have a larger premium than individuals with lower income levels.

There is more to this than meets the eye.

The first thing to understand is that the premiums for 2017 will be determined with reference to income reported on a 2015 tax return.  This makes sense since that is the most recent information available at the time that the 2017 premiums begin.  In 2018, the relevant income information will come from the 2016 tax return. Meaning that at the end of this month, each Medicare-eligible individual will lock in place the income that will be used to determine his or her 2018 Medicare premium.   

While you can’t do anything at this time to affect 2017 premium rates, there are some proactive strategies you can take to affect 2018 premiums.

Next year, at this time, the premium announcement will include a 6th income based bracket.  They are dividing $107,001-$160,000 into $107,001-$133,500 and $133,501-$160,000.

The chart below displays the significant increase to the two highlighted tax brackets when these changes take place.

medicare-chart

Brackets would be doubled in the case of a couple filing a joint tax return.

A second income tax concept that is important to understand is “modified adjusted gross income”. Modified adjusted gross income is your adjusted gross income (AGI) increased by tax-exempt income.  AGI is the number found at the bottom of your income tax form, 1040.  It is income minus certain deductions such as IRA deduction, student loan interest, and more.  “Adjusted gross income’ is different from “taxable income” and is unaffected by itemized deductions (such as charitable giving).  

The key planning goal is to lower items of gross income rather than focusing on deductions.

This brings me to the heart of this article. 

What actionable things are possible this month (December 2016) to lower Medicare premiums that will be assessed in 2018?

  1. The most important opportunity is to pay attention to how capital gains income will increase your income and in large part can be controlled. Instructions can be given to brokers and investment advisers to do what they can to reduce capital gains between now and year end.
    • Taking capital gains or not taking capital gains is a choice.
    • Capital losses can be used to offset capital gains, this is also known as tax loss harvesting. 
  2. Required minimum distributions can also be a trigger for higher Medicare taxes. To the extent that distributions remain unpaid for 2016, there is the opportunity to deflect that income to a qualified charity to keep modified adjusted gross income under control.
  3. If there is a choice between using taxable IRA funds or after-tax dollars to fund living expenses, the after-tax dollars could have a smaller impact on modified adjusted gross income.
  4. Similarly, within an after-tax account, it might be beneficial to use assets that do not lead to problematic capital gains income.

Planning insights such as this one illustrate the benefit of an integrated approach to investments, financial planning and tax planning.