Thirty-One Years of Growth Arrive at Once
A 72-year-old retiree opens a statement and sees that the deferred annuity he bought in 1995 is now worth $250,000. He paid $50,000 for it and let the money compound tax-deferred for 31 years. When the contract reaches its maturity date, he elects to take the lump sum. The check lands in his bank account, and for a moment it feels like the annuity has delivered exactly what he bought it to provide. Then the tax return catches up. Two years later, Medicare does too.
The $50,000 he originally contributed does not count as income because that money had already been taxed. The remaining $200,000 does. It lands in a single tax year as ordinary income and can trigger higher Medicare Part B and Part D premiums approximately two years later.
The annuity spread its growth across three decades. The tax return receives it all at once.
Why $200,000 Lands in One Year
A nonqualified annuity is purchased with after-tax money outside an IRA or workplace retirement plan. Its investment gains grow without current taxation until money leaves the contract. If the owner fully surrenders the annuity for one check, the IRS generally treats the original investment as a tax-free return of principal. Everything above that investment is taxable as ordinary income, not at the lower long-term capital-gains rate.
For this retiree:
- Original investment: $50,000
- Lump-sum payout: $250,000
- Ordinary taxable income: $200,000
That taxable gain enters adjusted gross income. Medicare then adds any tax-exempt interest, including municipal-bond interest, to arrive at the modified adjusted gross income (MAGI) used for its income-related monthly adjustment amount, or IRMAA. The taxable portion of his Social Security benefits, pensions, IRA distributions, interest, and any Roth conversion can pile onto the same return. A retiree whose normal MAGI is $90,000 could suddenly report close to $290,000.
The Medicare Bill Arrives Two Years Later
Medicare ordinarily uses tax information from approximately two years earlier. A lump sum received in 2026 would generally affect Part B and Part D premiums in 2028. The exact 2028 premiums and income brackets have not been announced. The current 2026 schedule still shows the potential scale of the hit. Under that schedule, a single filer with MAGI between $205,001 and just under $500,000 pays $649.20 a month for Part B, compared with the standard $202.90. A separate $83.30 monthly surcharge attaches to Part D coverage.
That is $529.60 in additional Medicare costs each month, or approximately $6,355 over a full year, using current premiums as a yardstick. If a married couple files jointly and both spouses have Medicare, the same household income can generate a surcharge for each person. The actual 2028 cost will depend on the brackets and premiums in effect then. The two-year delay is what makes the bill so easy to miss. By the time the letter arrives, the payout may have been spent, reinvested, or used to pay taxes from two years earlier.
Form SSA-44 Probably Will Not Undo It
Form SSA-44 can reduce an IRMAA surcharge after certain life-changing events, including retirement, work reduction, divorce, the death of a spouse, or the qualifying loss of employer pension income. Cashing out a personally owned annuity is not one of those events. Neither is a Roth conversion, a voluntary home sale, or an unusually large IRA withdrawal.
If the annuity created a one-time income spike, the surcharge will ordinarily last for one premium year before Medicare moves to a later tax return. That is better than a permanent increase, but an extra $6,000 or more is still an expensive farewell to a contract the retiree may never have needed to cash out.
The Choices That Exist Before the Payout
Three alternatives deserve attention while the money remains inside the contract:
- Annuitize the contract. Periodic payments generally divide each check between taxable earnings and a tax-free return of the owner’s investment. That spreads the income over multiple years, although the election may be irreversible.
- Consider a direct Section 1035 exchange. Moving the value directly into another qualifying annuity can preserve the tax deferral. Taking possession of the check first can destroy that treatment.
- Ask whether partial withdrawals are available. For many nonqualified annuities, earnings come out before principal, but smaller withdrawals can still spread those taxable earnings across several calendar years.
If the lump sum has already been issued, the planning window narrows. The retiree can still avoid stacking an optional Roth conversion or unnecessary IRA withdrawal onto the same return and should budget now for the possible Medicare surcharge two years later. The annuity did what it promised. It compounded without an annual tax bill. The surprise came from collecting 31 years of growth in one afternoon.
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