The Stealth Tax That Costs High-Income Retirees Thousands Every Year

A lot of people end up strapped for cash in retirement. But then there are those retirees who end up with a few million dollars in savings after years of hard work and careful spending.

Clearly, it’s better to have a higher income in retirement than a lower one. But if you end up with a generous retirement income, you run the risk of getting hit with a stealth tax that throws a good number of seniors for a loop.

The hidden risk of having a higher income

Many retirees end up enrolling in Medicare once they turn 65. But the cost of Medicare Part B hinges on what your income looks like. And the higher it is, the more it will cost you.

Higher earners in retirement are assessed a surcharge on their Medicare premiums known as income-related monthly adjustment amounts, or IRMAAs. And those IRMAAs could add hundreds of dollars a month to your Medicare costs.

This year, IRMAAs start to take effect for singles with an income of over $109,000 and married couples with an income of over $218,000. IRMAAs are also tiered so that the higher your income is, the more of a surcharge you face.

But the highest IRMAAs could add $487 a month to your Medicare premiums this year. When s added on to the standard Medicare Part B premium, it amounts to almost $700 a month for Part B alone.

To be clear, IRMAAs don’t impact the majority of retirees. Only an estimated 8% of Medicare enrollees face IRMAAs each year. But financial planners like to warn higher earners of this stealth tax because those surcharges can come as a huge and unwanted surprise.

How high-income retirees can avoid IRMAAs

While IRMAAs can be a sore spot for higher earners, the good news is that there are ways to reduce or even avoid them.

First, time gains in taxable accounts strategically. Taking large gains in a single year could drive your income up and increase the risk of IRMAAs. And if you end up with large gains, try to sell other assets at a loss to offset them when it makes sense to do so.

Secondly, do Roth conversions ahead of retirement if you have most of your savings in traditional accounts. Roth withdrawals don’t count as taxable income and therefore don’t get factored in when determining IRMAAs.

However, time those conversions strategically, and aim to spread them out. Otherwise, you could end up with a very high income one year — and IRMAAs a couple of years later.

If you don’t manage to do a large enough Roth conversion before retirement, be strategic with your required minimum distributions (RMDs), which also count as taxable income. Doing qualified charitable donations wipes out the tax liability on RMDs.

IRMAAs can be a huge pain point for higher earners in retirement. It’s important to know they exist and do your best to avoid them. Good planning could spell the difference between paying thousands extra each year versus keeping that money in your pocket.