Recently, I wrote about a double-whammy to future retirement income for some higher-income clients in 2016. Although there is not likely to be a cost-of-living-adjustment for Social Security benefits next year, Medicare premiums may increase sharply for some, resulting in a net decline in retirement income net year.
My column prompted a slew of anxious emails from financial advisers. Does that mean their clients who elected to file and suspend their Social Security benefits would be hit with a big Medicare Part B increase next year?
Yes, unfortunately it does.
Don't panic. Delaying Social Security benefits until they are worth the maximum amount at age 70 is still a good strategy for clients who want to increase their future retirement income. But that decision could be painful in the short run.
First, let me review the situation.
Normally, Medicare Part B premiums are deducted from monthly Social Security benefits. In 2015, most Medicare beneficiaries pay $104.90 per month for Medicare B, which covers outpatient services and doctor visits. Medicare A, which covers hospitalization, is free.
About 25% of retirees — individuals with a Modified Adjusted Gross Income over $85,000 or married couples with a combined MAGI of $170,000 or more — pay higher monthly premiums for Medicare Part B, and in some cases, a lot more. MAGI includes annual adjusted gross income plus tax-free interest.
There are five Medicare premium brackets. In 2015, the surcharges for Medicare Part B range from $42 to $230.80 per month on top of the standard $104.90-per-month premium. These premiums, as much as $335.70 per month, apply per person, so married couples where both spouses are Medicare age would pay twice as much.
The income brackets are based on the latest available tax return. A 2014 tax return filed in 2015 will be the basis for the Medicare premiums paid in 2016.
The 2015 Social Security and Medicare trustees report projects a 52% increase in Medicare Part B premiums for 2016. The actual increase, which may vary from the projection, will be announced by the Department of Health and Human Services in the fall.
However, only some Medicare beneficiaries will pay the higher premium next year. That's because the Social Security Act contains a “hold harmless” provision that protects the vast majority of Social Security beneficiaries from paying a larger increase in Medicare Part B premiums than they receive in a Social Security COLA increase in order to avoid a net reduction in their Social Security benefit.
No increase in Social Security benefits means no Medicare Part B premium hike for most beneficiaries.
But there is an exception to the hold-harmless provision, and it is likely to affect many high-income clients. Anyone who is subject to Medicare premium surcharges is not protected by the hold-harmless provision. Neither are individuals who are newly entitled to Social Security in 2016 or those who are enrolled in Medicare but who have not yet started to collect Social Security benefits.
That includes clients who elected to file and suspend their Social Security benefits. This claiming strategy allows an individual at 66 or older to file for benefits but to suspend them until later. That allows them to accrue delayed retirement credits worth 8% per year for every year they postpone collecting benefits beyond full retirement age up to age 70 for a potential benefit increase of 32%.
But because individuals who have elected to file and suspend are not actually receiving benefits, they can't experience a net decline in benefits if Medicare premium increase. Therefore, they will pay a higher Medicare Part B premium in 2016.
Is there a way to avoid the higher Medicare Part B premiums next year? Yes, but it could prove to be a costly mistake in the long run.
As long as a retiree receives Social Security benefits for November (paid in December 2015) and December (paid in January 2016) and have their Medicare Part B premiums deducted from those benefits, the hold-harmless provision will apply. That also assumes the retiree's income does not exceed $85,000 if single or $170,000 if married filing jointly.
So there's the tradeoff: If clients want to avoid major hike in Medicare Part B premiums next year, they need to apply for Social Security benefits by October so they can begin collecting them by November and have their Medicare Part B premiums deducted from those benefits. But it means forfeiting the annual 8% per year increase in future Social Security benefits. (This assume the clients' MAGI for 2014 does not exceed $85,000 if single or $170,000 if married. If their income is higher, they will not be protected from an Medicare premium hike even if they begin receiving Social Security benefits before the end of this year).
Keep in mind that a 50% increase in Medicare Part B premiums — approximately $50 per month or $600 per year — is still relatively small relative to a Social Security benefit of $2,400 per month at 66 could increase by $768 per month by delaying until age 70.
I've discussed this dilemma with Michael Kitces, author of the Nerd's Eye View blog, and he agrees that a desire to avoid a short-term hike in Medicare premiums could prove to be a costly mistake in the long run. He recently published an analysis of this issue.
(Questions about Social Security? Find the answers in my ebook.)