January surprise of vanishing Social Security COLA

Now that it’s January, financial advisers should prepare themselves for an onslaught of questions from clients asking why their monthly Social Security check stayed the same or even declined this month. After all, weren’t Social Security benefits supposed to increase by 2% in 2018?

Yes, Social Security benefits are 2% higher than last year, boosting average retirement benefits by about $27 per month and maximum benefits claimed at full retirement age by about $100 per month. But depending on your clients’ income, most of that benefit hike may be wiped out by higher Medicare premiums and in some cases, result in a net decline in Social Security benefits in 2018.

In most cases, Medicare Part B premiums are deducted directly from Social Security benefits. This year, most Medicare beneficiaries will pay $134 per month for Part B, which pays for doctors’ fees and outpatient services. That’s a $25-per-month increase over the 2017, nearly wiping out the Social Security COLA for many retirees.

But some higher-income retirees who are subject to monthly Medicare surcharges, officially known as Income-Related Monthly Adjustment Amount or IRMAA, will pay substantially more for their Medicare Part B premiums and Medicare Part D prescription drug plans this year.

The amount of the monthly Medicare Part B premiums, including the IRMAA surcharges, range from $187.50 per month to $428.60 per person in 2018. The surcharges are the same as in 2017, but some of the income tiers that trigger those premiums changed this year for the first time. This year’s Medicare premiums are based on 2016 federal tax returns.

HIGHER SURCHARGES

The clients who are affected by these higher surcharges in 2018 are individuals whose modified adjusted gross income, which includes any tax-free interest, topped $133,500 in 2016 and married couples whose joint income exceeded $267,000 in 2016.

For example, a single client whose income totaled $150,000 in 2015 was in the third income tier and paid a total $267.90 per month for Medicare Part B in 2017. But this year, that client was bumped into the fourth income tier and will pay $348.30 per month for Medicare Part B — an increase of $965 per year even though her income did not change from 2015 to 2016.

The same new income tiers also apply to Medicare Part D prescription drugs plans in 2018. So that same single client, who had been paying a monthly surcharge of $34.20 on top of her usual prescription drug premium in 2017, will now pay a surcharge of $54.20 per month plus her usual Part D premium. That’s an increase of $240 per year. When you add them together, her Medicare premiums increased by more than $1,200 this year before she ever sees a doctor or goes to the pharmacy.

Medicare premiums are charged per person so married clients where both spouses are 65 or older and enrolled in Medicare could see twice as big a jump in Medicare Part B and D premiums this year if they are bumped into a higher income tier based on the new rules.

LIFE-CHANGING EVENTS

There are strict rules for appealing Medicare surcharge if your client has experienced a life-changing event such as divorce, widowhood, remarriage or retirement since the latest available tax return.

Speaking of widowhood, surviving spouses can also be shocked by an unexpected increase in Medicare premiums. Let’s say a married couple’s joint income is below the $170,000 level that would trigger an IRMAA surcharge. But once the husband dies, the widow’s income will be based on individual thresholds that trigger an IRMAA surcharge once modified adjusted gross income tops $85,000 a year.

An adviser could help that client by suggesting the widow convert some of her traditional IRA to a Roth IRA in the year of her husband’s death while she can still file a joint tax return. She could convert part of her IRA and increase her income up to $170,000 without triggering a Medicare surcharge two years in the future and would reduce her future required minimum distributions (RMDs), which could help hold the line on future Medicare surcharges.

Going forward, the widow could send a portion of her RMDs each year directly to a charity to hold down her modified adjusted gross income and possibly reduce or eliminate future Medicare IRMAA surcharges.

Mary Beth Franklin, a certified financial planner, is a contributing editor for InvestmentNews.