Don’t get me wrong. I believe in the free markets. I believe in the power of the individual. I support rugged, entrepreneurship and risk-taking. These attributes are what I believe make our country so great. You can be born poor and retire with enormous wealth.
Many of us believe that the private sector can do things far more efficiently than the federal government. Many of us also laugh at the incompetency of the government bureaucracy. But is the government always incompetent and inefficient? Some of us would say yes. However, in the case of certain rules, regulations and laws concerning healthcare and retirement, government has the last laugh.
The Cost for Medicare
What am I talking about? Think of the following two rules. When we become eligible for Medicare, the cost for Medicare Part B and Medicare Part D are based on our income when we are eligible for these programs. But it’s not just any income, it is the modified adjusted gross income (MAGI). MAGI includes almost all income sources, including tax-free interest. If you know how to look at your tax forms, you will calculate your MAGI by adding the values on line 8B and line 37 of your IRS Form 1040.
When we reach age 70.5, we must start our distributions from our qualified tax-deferred accounts. These accounts are often IRAs, 401(k)s, or something similar. Some of us were fortunate to have years and years of deferral inside these arrangements. However, the distributions from these plans are part of your MAGI. You cannot tell me that was not by design. The powers that be who set these rules in place knew exactly where the proverbial bodies are buried.
By the time many Americans, and sometimes the occasional financial advisor, figures this all out, it is too late. Too late for what? Too late to change gears to keep taxable income down in retirement, which could keep retirement health costs down as well.
Instead most people will continue to do what the consensus of the experts tell them to do. What is that? Keep on deferring income for later and taking those tax deductions today. But at some point, the bill comes due. It’s time to pay the tax man for all the years that he let you escape taxes on the earnings inside pre-tax retirement accounts. It does not matter if these retirement accounts hold securities or non-securities. The bill must be paid. Paying that bill could increase your taxable income, which may likely increase the cost for your healthcare. (For more from this author, see: The One Mandatory Cost in Retirement.)
Medicare Premiums Deducted from Social Security
Remember if you are enrolled in Medicare Part B and are collecting Social Security retirement income, you must have your premiums deducted from your benefit. Said another way, as the cost for Medicare Part B increases the less Social Security you will receive. Medicare Part D does not have to be deducted from Social Security. It’s a good idea though so you don’t forget to pay the premium. Like Part B, Medicare Part D premiums are based on your modified adjusted gross income. It’s possible that the very same great opportunity to save for retirement, comes back to bite you later. (For more from this author, see: Sometimes the Less Expensive Option Costs You More.)
Is the government so incompetent and inefficient here? I would argue no. I think they are brilliant with how they pulled the wool over our eyes. They let us save on taxes in the present and potentially lower our effective tax rate, only to nail us later when our effective rate is likely higher because we are no longer contributing to tax-deferred retirement plans, our dependents are usually grown and out of the home, and our mortgages may be paid off or close to it (little or no mortgage interest deduction). They found a way to legally raise tax revenue, pay less out in Social Security and charge more for Medicare premiums. Oh, and to add insult to injury, the portion of your Social Security that is taxable is remains taxable whether you receive that amount or not. In some extreme examples, the cost of Medicare is greater than the Social Security benefit received. That requires you to pay for some of your Medicare Part B out-of-pocket.
I don’t like the outcome, but this is an ingenious plan by our benevolent government. The good news is it doesn’t have to end this way. Younger Americans have time to make changes so that modified adjusted gross income does not become a problem later in retirement. Or at least, not as big of a problem. The bad news is it may be too late for many. Talk to an advisor who understands this. If not for you, then at least for your children.
(For more from this author, see: Your Wants vs. Needs in Retirement.)