He Moves $700,000 Into Tax-Free Municipal Bonds as 20-Year Yields Reach 4.5%. The IRS Exempts His $31,500 in Annual Interest. Medicare Counts Every Dollar
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On November 12, 20-year AA municipal bond yields sat around an estimated 4.5%. A single retiree takes that yield and moves $700,000 into munis. The bonds pay $31,500 a year in interest, which is generally exempt from federal income tax. He assumes his Medicare premiums will skip that interest too. Social Security counts every dollar of it. All estimates here are based on the 2026 Medicare plan year.
Most retirees never hit this problem. The income-related monthly adjustment amount (IRMAA), a surcharge added to Medicare Part B and Part D premiums, affects only about 8% of Medicare beneficiaries. A single filer whose income, municipal interest included, stays at or below $109,000 ($218,000 joint) pays the 2026 Part B base premium of $202.90 and no Part D surcharge. Retirees close to that line are the ones who need to run the numbers.
Coupon Cash Sets the Number Medicare Sees
The interest generally escapes federal income tax, but he still must report it on his return. That reported figure drives the Medicare math, although it doesn’t always match the coupon payments he receives. Yield to maturity combines coupon cash with the gain or loss as a bond’s price moves toward par, so a premium bond quoted at 4.5% can pay a higher coupon. To collect exactly $31,500 in cash, he buys $700,000 face value of 4.5%-coupon bonds at par, where coupon and yield match.
How “Tax-Free” Interest Buys a Surcharge
For IRMAA, Social Security sets modified adjusted gross income (MAGI) as adjusted gross income plus tax-exempt interest income. That means Form 1040 line 11a plus line 2a.
Say he has $95,000 in pension and taxable IRA income, with no Social Security benefits yet. That leaves him under the first threshold, paying the standard premium. The bond interest raises his MAGI to $126,500, which lands in the first tier (over $109,000 up to $137,000). Part B rises by $81.20 a month to $284.10, and Part D adds $14.50. Together that comes to $1,148.40 a year using 2026 rates, about 3.6% of his interest. That would leave him with roughly a 4.34% yield after the surcharge, although his actual future Medicare costs remain unknown. He also sits just $10,500 below the second tier, where the Part B add-on reaches $202.90.
The same add-back shows up in the income tax rules. Under 26 U.S.C. § 86(b)(2)(B), the IRS adds tax-exempt interest back in when it decides how much of your Social Security is taxable. So muni interest can also make more of his benefits taxable.
Married readers face a later version of the problem. A couple with the same $126,500 joint MAGI pays no surcharge, since the joint threshold is $218,000. If one partner dies, the survivor generally starts filing single. The income thresholds become much lower, so even a smaller household income can trigger a surcharge.
Why 2027 Is the Year That Sets His Premiums
Social Security uses the most recent federal tax return the IRS provides, which typically means income from two years back. Bonds bought now put a few weeks of interest on his 2026 return, which sets 2028 premiums. His first full year of coupons, 2027, sets his 2029 premiums. Those future brackets will change: the first single threshold went from $106,000 in 2025 to $109,000 in 2026.
Form SSA-44 won’t undo the surcharge simply because he bought bonds. Social Security allows new premium calculations after certain life-changing events, including retirement, reduced work hours and divorce. Buying municipal bonds isn’t one of them.
Treasuries Trigger the Same Surcharge
The 20-year Treasury par yield hit 5.48% on November 12. At that yield, a hypothetical $700,000 Treasury purchase at par would produce $38,360 in annual taxable interest, bringing his MAGI to $133,360. That lands in the same first tier and costs the same $1,148.40 surcharge. At this income, Medicare charges munis and Treasuries the same, so the choice between them comes down to federal income tax and how much Social Security each makes taxable. The surcharge comes with the income itself, whatever kind of bond pays it.
Run These Numbers Before Buying
- Check the interest Medicare will see. Coupon payments aren’t always the amount reported on your tax return. Bonds bought at a premium can produce less reportable interest, while some bonds generate interest before paying any cash. Estimate what will appear on Form 1040, line 2a.
- Test your total MAGI against the brackets. At $95,000 of other income, this retiree has $14,000 of room below $109,000. At a 4.5% coupon, that buys about $311,000 of bonds before the first surcharge starts. Above that, municipal interest held in a taxable account counts toward IRMAA in full.
- Married? Model the survivor years. Run your expected household income through the single brackets. If the result lands within $10,000 of a threshold, compare the muni plan with holding fixed income inside a Roth IRA, where qualified withdrawals stay out of MAGI.
There is a silver lining. Using 2026 rates, he would still keep about $30,352 of his $31,500 in annual bond interest after the Medicare surcharge, and that interest remains exempt from federal income tax. Municipal bonds may still beat taxable alternatives. The smart move is to compare what he keeps after taxes and Medicare premiums before deciding where to put his $700,000.
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Gerelyn Terzo is the author of dividend investing handbook "Dividend Investing Strategies: How to Have Your Cake & Eat It Too." A veteran financial journalist, she covers agri-finance for outlets like Global AgInvesting and the broader stock market and personal finance for 24/7 Wall Street. She began at CNBC and later helped launch Fox Business in New York. Gerelyn currently resides in Woodland Park, Colorado and dabbles in nature photography as a hobby.
