My Annual Warning: IRMAA Is an Unwelcome Companion at Age 65+

Medicare may apply a surcharge on your Part B and Part D premium.

Too many Americans - even those approaching retirement - are unaware of how Medicare works and what they must pay for this coverage. That's unfortunate, since medical coverage and care are large budget items in retirement. And the cost not only of care (out-of-pocket financial responsibility for services received), but also coverage (premiums) can drain retirement resources.

The cost of coverage isn't the same for all enrollees. Some pay higher premiums because they report higher taxable income in a given year - whether that income is derived from higher earnings, mandatory withdrawals from a tax-deferred retirement account, or the sale of an asset (like a residence, second home, or business). Those higher premiums are traced directly to IRMAA.

Depending on your situation, you may or may not be able to avoid premium surcharges. But your chances of avoiding paying higher Medicare premiums drop to near zero if you don't understand the process and take steps prior to retirement to create the tools to fight back financially.

IRMAA Defined

The Income-Related Monthly Adjustment Amount is a surcharge that Medicare Part B (outpatient services) and Part D (prescription-drug coverage) enrollees pay when their taxable income exceeds certain thresholds. In 2023, any Medicare enrollee whose taxable income is greater than $97,000 (single filer) or $184,000 (joint filer) will be assessed the surcharge. The amount of the surcharge increases as income increases.

IRMAA is always calculated on income received two years prior. That's because the federal government needs concrete income information (your tax return) to make the calculation.

Example: The calculation to determine whether the IRMAA surcharge applies to your 2023 Part B and Part D premiums is made in 2022. The most recent income tax return that you filed prior to the calculation is your 2021 tax return, which you filed sometime between January and April 2022.

Not sure whether the IRMAA surcharge applies to you? Don't worry - the Social Security Administration does the calculation and inform you.

The Rationale for IRMAA

Many Americans believe that they prepay their Medicare premiums through the federal payroll (FICA) taxes that are deducted from their paychecks during their working years. That's simply not true. The 2.9% Medicare payroll tax (split equally between employer and employee, or paid in full by self-employed people) prepays Part A (inpatient, hospice, home health care) only. Anyone who's earned (or is married to someone who's earned) a minimum amount for 40 calendar quarters (equivalent of 10 years) and paid payroll taxes is entitled to premium-free Part A coverage beginning at age 65.

Americans enrolled in Medicare Part B or Part D pay a monthly premium for that coverage. These enrollees pay a standard Part B and Part D premium equal to about 25% of the cost of these programs. The balance is paid from general funds in the federal treasury. Note that seniors enrolled in Medicare Part C (a private alternative to traditional Medicare), which covers about half of Medicare enrollees, are affected by the IRMAA surcharge because they pay the Part B premium to access Part C coverage.

Example: The standard Part B premium in 2023 is $164.90 (which is lower than 2022 due to a one-time event). Enrollees pay that amount directly or have it deducted from their Social Security checks. But the average enrollee incurs about $660 in monthly claims. The difference (nearly $500) is paid from the same federal budget that funds defense, education, transportation, and other priorities.

As with many government programs, subsidies are subject to income. When income exceeds a certain figure, the subsidy is reduced. The same process occurs with Part B and Part D premiums.

Example: You continue to work at age 69. You're covered by Medicare. You earned $150,000 in 2021 (the base year to calculate your 2023 Part B surcharge - it always lags two years). Your 2023 Part B premium is not the standard $164.90, but rather $329.70. If you also enroll in Medicare prescription-drug coverage, you pay the Part D premium charged by your private Part D insurer, plus a $31.50 monthly surcharge. You end up paying surcharges totaling about $2,350 in 2023.

This income-based surcharge doesn't hit only working seniors with six-figure incomes. It can affect retirees who make Required Minimum Distributions (RMDs) from a tax-deferred retirement account (even if they don't need the money that year), sell an asset, or receive a lump-sum annuity payment.

How to Minimize IRMAA's Impact

You can't slay IRMAA. But you can create strategies to avoid her during at least some years. And a key ally in this strategy is a Health Savings Account. Here's how:

When you withdraw funds from a tax-deferred retirement account, the distribution is included in taxable income. That's the bargain you accepted - in exchange for income-tax-free contributions and balance growth, you implicitly agreed to taxation of all withdrawals and required minimum distributions beginning at (thanks to the recently passed SECURE 2.0 Act) age 75 for most Americans (versus age 72 previously). It doesn't matter whether the withdrawal is to buy a car, pay a utility bill, or reimburse a medical expense. The only exception is if you can offset the taxable withdrawal with a tax deduction, such as a charitable contribution or medical expenses greater than 7.5% (for senior citizens; it remains 10% for other taxpayers).

Health Savings Account contributions enjoy slightly better tax benefits (free of federal income AND payroll taxes, and state income taxes except in California and New Jersey) and equal benefits (tax deferral) on account growth. But withdrawals from Health Savings Accounts for qualified expenses are not included in taxable income. You can use this tax benefit to fall below the IRMAA surcharge threshold.

Example: You're a single filer, age 68, in 2023. Your IRMAA surcharges start when your income exceeds $97,000. You worked half the year, then began collecting Social Security and withdrawing funds from your tax-deferred 401(k) plan to balance your budget, which includes $3,000 in qualified medical expenses incurred late in the year. You've realized a taxable income of $95,000 through mid-December and must pay those $3,000 of medical expenses.

If you withdraw the $3,000 from your tax-deferred 401(k) plan, your taxable income rises to $98,000. That means you'll pay an IRMAA Part B and Part D surcharge of about $1,000 in 2025 (the year that uses 2023 income to calculate surcharges).

On the other hand, if you've built a balance in your Health Savings Account and withdraw the $3,000 from that account, your taxable income remains $95,000. You'll be subject to no IRMAA surcharges.

This strategy is most effective only when your income is close to pushing you into a new IRMAA bracket. In most years, withdrawing funds from a Health Savings Account versus a tax-deferred retirement account won't affect your IRMAA surcharge.

But you always enjoy tax benefits when you pay qualified expenses through a Health Savings Account. Because these withdrawals aren't included in taxable income, you always pay less in taxes. You may or may not pay the IRMAA surcharge, but if you're in the 22% federal tax bracket, withdrawing $3,000 for qualified expenses from a Health Savings Account rather than a tax-deferred 401(k) plan saves $660 in federal taxes (and additional state income-tax savings if your state taxes income).

The Bottom Line

Health Savings Accounts always offer tax savings and sometimes an opportunity to avoid Medicare premium surcharges. They should be a part of your retirement planning. But like other aspects of retirement preparation, the sooner you understand the effect and act, the more you'll benefit later in life.

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