How Roth Conversions Can Affect Your Medicare Premiums

As retirement approaches, many individuals seek strategic financial maneuvers to reduce their tax burden and preserve their hard-earned wealth. One such tactic is the Roth IRA conversion, which allows for tax-free withdrawals during retirement. However, it’s essential to understand how Roth IRA conversions interplay with your overall financial profile. These conversions can inadvertently lead to higher Medicare premiums due to the Income-Related Monthly Adjustment Amount (IRMAA), a surcharge applied to income exceeding certain thresholds.  Essentially, the benefit in one area can become a liability in another.

Understanding IRMAA and Its Impact

A Medicare beneficiary’s Modified Adjusted Gross Income (MAGI) from two years prior dictates their Medicare Parts B and D premiums, as outlined by the Social Security Administration (SSA). Consequently, an individual’s MAGI from 2023 will influence their 2025 premiums. The Internal Revenue Service (IRS) communicates financial information to the SSA, and a sliding scale of percentage-based tables determines adjustments based on a filer’s modified MAGI. Individuals with higher incomes are subject to increased premiums, according to the IRMAA. In 2025, single filers with a MAGI exceeding $106,000 will incur IRMAA surcharges. Beneficiaries surpassing the IRMAA thresholds can use financial planning strategies to manage premium rates.

Roth Conversions and Taxable Income

Conversions from a 401(k) or traditional IRA to a Roth IRA are taxed on the converted amount during the transactional year. The conversion increases an individual’s taxable income for that year, which can push their MAGI above the IRMAA thresholds two years later.

Strategies to Mitigate IRMAA Impact

Retirees can manage their risk of incurring an IRMAA with informed and prudent financial transactions. Here are a few clever ways to manage taxable income:

• Incremental Conversions — Smaller Roth conversions spanning multiple years can limit annual taxable income and avoid income spikes that cross IRMAA thresholds. For example, a $200,000 conversion spread over four years at $50,000 annually can help prevent an income surge.
• Timing Considerations — Performing Roth conversions before enrolling in Medicare can prevent immediate premium increases. Because IRMAA calculations consider income from two years prior, converting before age 63 can be particularly beneficial. Eligibility for Medicare begins at age 65 for most people. In that situation, the IRS would count the income from age 63, and the income from a Roth conversion before 63 would not apply. This can help avoid higher IRMAA surcharges in initial Medicare years. Additionally, shifting funds to a Roth IRA early allows for tax-free withdrawals later in retirement to mitigate future potential IRMAA surcharges.
• Alternative Income Management — Individuals can leverage taxable investment accounts and other income sources to reduce their MAGI in high-income years. This approach requires careful income and tax balancing and is best conducted under the advice of a qualified financial advisor.

Another way to reduce the taxable income that affects Medicare premiums concerns the required minimum distributions (RMDs) that begin at age 73. Required minimum distributions are mandatory withdrawal minimums retirees must make from their retirement accounts (401(k)s, 403(b)s, and traditional IRAs) each year. RMD withdrawals are taxed as regular income. Designated Roth accounts are exempt from RMDs. Retirees with substantial retirement account balances can opt for Roth conversions before reaching RMD age. By anticipating the impact of RMDs on taxable income and Medicare premiums and converting before they take effect, retirees can manage their tax brackets and minimize future IRMAA surcharges.

Potential Pitfalls and Considerations

Roth conversions can offer long-term tax benefits and reduce future Medicare premium surcharges. However, they can also present challenges without thoughtful planning. Several factors can significantly affect how successful a conversion strategy is, including:

• Tax Bracket Creep: Large conversions can push retirees into higher federal and state tax brackets and increase their tax burden. Before proceeding, retirees should calculate the combined tax impact and consult a financial advisor if they are unsure whether a conversion is advantageous to them in their situation.
• State Taxes: Retirees should consider that states vary in how they tax Roth conversions and acquaint themselves with their state’s tax treatment of conversions.
• Future Tax Legislation: Tax law changes can influence the benefits of Roth conversions. Staying informed about legislative developments can help retirees make informed and timely decisions about their Roth conversions.

Because there is so much informed strategy involved with Roth conversions, the best way to avoid tax consequences and increased Medicare premiums is to consult a financial advisor who intimately understands the relationship between conversions, taxable income, and the various retirement milestones. Whether you are considering a Roth IRA conversion, trying to manage your taxable income or Medicare premiums, or just looking to optimize your retirement strategy, an SHP Financial advisor can help. Contact us today for a complimentary review of your finances.