By Robert Klein
Roth IRA conversions are an excellent tool for optimizing after-tax income throughout retirement, when done strategically as part of a holistic retirement income plan. Roth IRA conversions are under-utilized even though they can provide greater after-tax retirement income than would otherwise be possible.
The primary reason for this is a reluctance to plan for and prepay income tax liability attributable to conversions. This is the case even though current historic low-income tax rates and wide income brackets favoring Roth IRA conversions are slated to be replaced by higher pre-2018 tax rates and narrower income brackets beginning in 2026.
Potential Medicare Part B Premium Reduction
One of the benefits of converting taxable retirement income to nontaxable Roth IRA income through Roth IRA conversions is the potential reduction of Medicare Part B premiums beginning at age 65. After-tax retirement income will be increased to the extent that this can be accomplished.
Medicare Part B premiums are income sensitive. They’re determined using modified adjusted gross income (MAGI) from your federal income tax return two years prior to the current year. You can potentially reduce your spouse and your Medicare Part B premiums to the extent that you’re able to reduce your income beginning at age 63, through prior year Roth IRA conversions.
There are six income brackets that are used to determine monthly Medicare Part B premium amounts. In 2020, the premium amounts range from $144.60 to $491.60 per person. An Income Related Monthly Adjustment Amount (IRMAA), or surcharge, is assessed beginning when your MAGI exceeds $87,000 for an individual return or $174,000 for a joint return.
Per the table, the IRMAA surcharge can increase monthly Medicare Part B premiums by as much as $347.00 ($491.60 - $144.60), or $4,164 per year for those in the highest tax bracket. This can result in additional annual premiums of double this amount, or $8,328 for a couple.
Medicare Part D drug plan monthly premiums are also subject to an IRMAA surcharge that ranges from $12.20 to $76.40 per person with the same income brackets as Medicare Part B.
Roth IRA Conversion Surcharge after Age 62
Although timely Roth IRA conversions can be used to decrease Medicare Part B and D premiums and increase after-tax income throughout retirement, there’s a potential price to pay if the conversions occur after age 62. You and your spouse, if married, will pay higher Medicare Part B and D monthly premiums two years after the year of the conversions if the taxable amount of your conversions causes you to jump into a higher Medicare income bracket.
As an example, suppose John and Mary, age 64 and 63, respectively, are married and their 2018 modified adjusted gross income, or MAGI, is $228,000 prior to doing any Roth IRA conversions. Let’s assume that John and Mary do conversions of $23,000 and $22,000, respectively, for a total of $45,000.
Fast forward two years to 2020 when John and Mary are 66 and 65, respectively, and are both on Medicare Part B. Using John and Mary’s 2018 MAGI of $228,000 prior to their Roth IRA conversions of $45,000, their monthly Medicare Part B premiums would be $289.20 each. They would pay a total of $3,470.40 each for the year, or $6,940.80 for both.
John and Mary’s actual 2018 MAGI is $228,000 increased by their taxable Roth IRA conversions of $45,000, or $273,000. This causes John and Mary to jump into the $272,001 - $326,000 Medicare income bracket, increasing their monthly Part B premiums from $289.20 to 376.00 each.
John and Mary’s total 2020 Medicare Part B premiums are now $4,512.00 each, or $9,024.00 for both. In summary, John and Mary’s 2018 taxable Roth IRA conversions of $45,000 resulted in an increase in their 2020 Medicare Part B premiums of $2,083.20 ($9,024.00 - $6,940.80).
Should You Do Roth IRA Conversions After Age 62?
John and Mary’s situation begs the question, should you do Roth IRA conversions after age 62 given the fact that they can potentially increase Medicare Part B and D premiums that you would otherwise pay without the conversions?
Assuming your goal is to minimize potential increases in Medicare premiums resulting from Roth IRA conversions, a staged Roth IRA conversion plan should be established 15 to 20 years before age 62. By starting your plan when you’re in your 40’s, you take the pressure off since you can convert smaller amounts and pay less tax each year on your conversions than would otherwise be possible if you begin your plan later.
Conversion amounts don’t have to, and generally shouldn’t, be the same each year. Current historic low federal income tax rates and wide tax brackets favor higher conversion amounts through 2025. In addition, strategic Roth IRA conversion opportunities, which can be discovered and analyzed through tax planning, as well as market-sensitive conversions, should always be on your radar.
Although the timely establishment and implementation of an ongoing staged Roth IRA conversion plan won’t necessarily result in the conversion of 100% of taxable retirement plan assets to Roth IRA accounts by age 63, it can provide the following nine benefits:
· Smaller taxable retirement accounts and taxable distributions
· Potentially reduced lifetime Medicare Part B and D premiums
· Reduced lifetime annual required minimum distributions, or RMDs, beginning at age 72
· Potentially smaller annual Roth IRA conversions that are less likely to cause you to be in a higher Medicare income bracket.
· Reduced dependency on taxable assets and less income tax liability throughout retirement
· Potentially reduced taxable Social Security benefits
· Reduced widow or widower’s income tax liability
· Reduced taxation of inherited retirement plan assets attributable to the “stretch IRA” being replaced with a 10-year rule for most beneficiaries effective January 1, 2020
Given the fact that the foregoing nine benefits of a staged Roth IRA conversion plan work together to optimize lifetime after-tax retirement distributions, it makes sense to continue doing income tax-sensitive strategic Roth IRA conversions after age 62. Paying increased Medicare Part B and D premiums in one or more years, the amount of which can be minimized through Medicare income bracket planning, is usually a small price to pay to accomplish this goal.
Finally, remember to include your Part B, Part D, and supplemental Medicare premiums in the above-the-line deduction for health insurance premiums on your income tax returns if you’re self-employed. This will soften the blow in years when Roth IRA conversions increase your premiums and throw you into a higher Medicare income bracket.
About the author: Robert Klein
Robert Klein, CPA, PFS, CFP®, RICP®, CLTC® is the founder and president of Retirement Income Center in Newport Beach, California. Bob is also the writer and publisher of Retirement Income Visions™, a blog featuring innovative strategies for creating and optimizing retirement income that Bob created in 2009.
Bob applies his unique background, experience, expertise, and specialization in tax-sensitive retirement income planning strategies to optimize the longevity of his clients’ after-tax retirement income and assets. He does this as an independent financial advisor using customized holistic planning solutions based on each client’s needs and personality.
Retirement Income Center has established relationships with various highly respected professional organizations and platforms to provide the firm’s clients with its comprehensive array of fee-based planning, management, and protection services.