How to Reduce IRMAA

How to Reduce IRMAA

Many retirees want to find ways to avoid or reduce IRMAA. Why do retirees hate Irma? No, not a person, IRMAA is Income Related Monthly Adjustment Amount. That means that your Medicare Part B and D premiums are increased because of your income. We are going to show how IRMAA is calculated and then share ways you can reduce IRMAA.

Medicare Part A is generally free at age 65, and most people enroll immediately. Part A provides hospital insurance for inpatient care. Part B is medical insurance for outpatient care, doctor visits, check ups, lab work, etc. And Part D is for prescription drugs. When you enroll in Parts B and D, you are required to pay a monthly premium. How much? Well, it depends on IRMAA.

IRMAA Levels for 2022

IRMAA increases your Medicare Part B and D premiums based on your income. There is a two year lag, so your 2022 Medicare premiums are based on your 2020 income tax return. Here are the 2022 premiums, based on your Modified Adjusted Gross Income, or MAGI.

2020 Single MAGI

$91,000 or less

$91,001 to $114,000

$114,001 to $142,000

$142,001 to $170,000

$170,001 to $500,000

$500,001 and higher

2020 Married/Joint MAGI

$182,000 or less

$182,001 to $228,000

$228,001 to $284,000

$284,001 to $340,000

$340,001 to $750,000

$750,001 and higher

2022 Monthly Part B / Part D

$170.10 / Plan Premium (PP)

$238.10 / PP + $12.40

$340.20 / PP + $32.10

$442.30 / PP + $51.70

$544.30 / PP + $71.30

$578.30 / PP + $77.90

How to Calculate MAGI

I have written previously about how the IRS uses a figure called Modified Adjusted Gross Income or MAGI. MAGI is not the same as AGI and does not appear anywhere on your tax return. Even more maddening, there is no one definition of MAGI. Are you calculating MAGI for IRA Eligibility, the Premium Tax Credit, or for Medicare? All three use different calculations and can vary. It’s crazy, but our government seems to like making things complex. So, here is the MAGI calculation for Medicare:

MAGI starts with the Adjusted Gross Income on your tax return. For Medicare IRMAA, you then need to add back four items, which you may or may not have:

  • Tax-exempt interest from municipal bonds
  • Interest from US Savings Bonds used for higher education expenses
  • Income earned abroad which was excluded from AGI
  • Income from US territories (Puerto Rico, Guam, etc.) which was non-taxable

Add back those items to your AGI and the new number is your MAGI for Medicare.

Why Retirees Hate IRMAA

The IRMAA levels are a “Cliff” tax. Make one dollar over these levels and your premiums jump up. Many retirees plan on a comfortable retirement and find out that their Social Security benefits are much less than they expected because of Medicare Premiums. For a married couple, if your MAGI increases from $182,000 to $228,001, you will see your premiums double. And while young people think it must be so nice to get “free” health insurance for retirees, this couple is actually paying $8,164.80 just for their Part B Premiums every year! And then there are still deductibles, co-pays, prescriptions, etc.

Sure, $228,001 in income sounds a lot for a retiree, right? Well, that amount includes pensions, 85% of Social Security, Required Minimum Distributions, capital gains from houses or stocks, interest, etc. There are a lot of retirees who do get hit with IRMAA. And this is after having paid 2.9% of every single paycheck for Medicare over your entire working career. That’s why many want to understand how to reduce IRMAA.

10 Ways to Reduce MAGI for IRMAA

The key to reducing IRMAA is to understand the income thresholds and then carefully plan out your MAGI. Here is what you need to know.

  1. Watch your IRA/401(k) distributions. Avoid taking a large distribution in one year. It’s better to smooth out distributions or just take RMDs.
  2. Good news, Roth distributions are non-taxable. IRMAA is another reason that pre-retirees should be building up their Roth accounts. And there are no RMDs on Roth IRAs.
  3. Be careful of Roth Conversions. Conversions are included in MAGI and could trigger IRMAA.
  4. If you are still working, keep contributing to a Traditional IRA or 401(k) to reduce MAGI. If you are self-employed, consider a SEP or Individual 401(k). The age limit on Traditional IRAs has been eliminated.
  5. Itemized Deductions do NOT lower AGI. While State and Local Taxes, Mortgage Interest, Charitable Donations, and Medical Expenses could lower taxable income, they will not help with MAGI for IRMAA.
  6. However, if you are 70 1/2, Qualified Charitable Distributions (QCDs) do reduce MAGI. If you are younger than 70 1/2, donating appreciated securities can avoid capital gains.
  7. Avoid large capital gains from sales in any one year. Be sure to harvest losses annually in taxable accounts to reduce capital gains. Use ETFs rather than mutual funds in taxable accounts for better tax efficiency. Place income-generating investments such as bonds into tax-deferred accounts rather than taxable accounts. Consider non-qualified annuities to defer income.
  8. If you still have a high income at age 65, consider delaying Social Security benefits until age 70.
  9. Once you are 65, you cannot contribute to a Health Savings Account (HSA). However, you may be able to contribute to an FSA (Flexible Spending Account), if your employer offers one. The maximum contribution for 2022 is $2,850 and you may be able to rollover $570 in unused funds to the next year.
  10. Avoid Married filing separately. File jointly.

Life-Changing Event

Medicare does recognize that situations change and your income from two years ago may not represent your current financial situation. Under specific circumstances, you can request IRMAA be reduced or waived if you have a drop in income. This is filed using form SSA-44, as a “Life Changing Event”. Reasons for the request include:

  • Marriage, Divorce, or Death of a Spouse
  • You stopped working or reduced your hours
  • You lost income-producing property due to a disaster
  • An employer pension planned stopped or was reduced
  • You received an employer settlement due to bankruptcy or closure

Outside of the “Life-Changing Event” process, you can also appeal IRMAA within 60 days if there was an error in the calculation. For example, if you filed an amended tax return, and Social Security did not use the most recent return, that would be grounds for an appeal.

A few other tips: If you are subject to IRMAA and have Part D, Prescription Drug, coverage, consider Part C. Medicare Part C is Medicare Advantage. Many Part C plans include prescription drug coverage, so you will not need Part D. And there is no IRMAA for Part C. Lastly, while you can delay Part B if you work past 65, be sure to sign up immediately when you become eligible to avoid penalties.

IRMAA catches a lot of retirees, even though they don’t have any wages or traditional “income”. Between RMDs, capital gains, and other retirement income, it’s common for retirees to end up paying extra for their Medicare premiums. If you want to learn how to reduce IRMAA, talk with your financial advisor and analyze your individual situation. I’m here to help with these types of questions and planning for clients.

Bonds in 2022

Bonds in 2022

Resuming last week’s Investment Themes, today we consider Bonds in 2022. It is a challenging environment for bond investors. We are coming off record low yields and the yield on the 10-year Treasury is still only 1.5%. At the same time, yields are starting to move up. And since prices move inversely to yields, the US Aggregate Bond index ETF (AGG) is actually down 1.74% year to date. Even including the yield, you’ve lost money in bonds this year. With stocks having a great year in 2021, it is frustrating to see bonds dragging down the returns of a diversified portfolio.

Inflation Hurts Bonds

Inflation is picking up in the US and globally. Supply chain issues, strong demand for goods, and rising labor costs are increasing prices. The Federal Reserve this week said they would be removing the word “transitory” from their description of inflation. And now that it appears that Jay Powell will remain the Chair, it is believed that the Fed will focus on lowering inflation in 2022. They will reduce their bond buying program which has suppressed interest rates. And they are expected to gradually start increasing the Fed Funds rate in 2022.

It is difficult to make accurate predictions about interest rates, but the consensus is that rates will continue to rise in 2022. So, on the one hand, bonds have very little yield to offer. And on the other hand, you will lose money if interest rates continue to climb. Then, to add insult to injury, most bonds are not maintaining your purchasing power with inflation at 6%.

Bond Themes for 2022

There aren’t a lot of great options for bond investors today. But here are the bond investment themes we believe will benefit your portfolio for the year ahead. This is how we are positioning portfolios

  1. We will be increasing our allocation to Floating Rate bonds (“Bank Loans”). These are bonds with adjustable interest rates. As rates rise, the interest charged goes up. These are a good Satellite for rising rate environments.
  2. Within core bonds, we want to reduce duration to shorter term bonds. This can reduce interest rate risk.
  3. We continue to hold Preferred Stocks for their yield. While their prices will come under pressure if rates rise, they offer a continuous cash flow.
  4. Ladder 5-year fixed annuities. I have been beating this drum for years. Still, multi-year guaranteed annuities (MYGA) have higher yields than CDs, Treasuries, or A-rated corporate and municipal bonds. If you don’t need the liquidity, MYGAs offer a guaranteed yield and principal.
  5. I previously suggested I-Series Savings Bonds rather than TIPS. These are linked to inflation and presently are paying 7.12%. Purchases are limited to $10,000 a year per person, and unfortunately cannot be held in a brokerage account or an IRA. Read my recent article for more details. I personally bought $10,000 of I-Bonds this week.

Purpose of Bonds

Even with a negative environment for bonds, they still have a role in most portfolios. Unless you have the risk capacity to be 100% in stocks, bonds offer crucial diversification. When we have a portfolio with 60% stocks and 40% bonds, we have an opportunity to rebalance. When stocks are down, like in March of 2020, we can use bonds to buy more stocks while they are on sale. And of course, a portfolio with 40% in bonds has much less volatility than one which has 100% stocks.

Yields may eventually go back up to more normal levels. While it would be nice to have higher yields, the process of yields going up will be painful for bond investors. Our themes are trying to reduce this “interest rate risk”. We hope to reset to higher rates in the future, while reducing a potential loss in bond prices in 2022.

Investment Themes for 2022

Investment Themes for 2022

Let’s look ahead to 2022 and consider what investment themes we believe should be incorporated into our portfolio models. This process is not meant to be a prediction of whether markets will be up or down. I don’t think anyone can time the market successfully. (Here is my letter to clients from March 21, 2020 for reference.) Rather, my goal is to add value to our investment process in three ways.

One, we want to tilt towards areas of relative value. That means when one category is cheap and another is expensive, we want to have more of the cheap stocks and less of the expensive stocks. This sounds obvious, but many investors chase performance without regard to valuation. Inadvertently, they load up on expensive stocks. Tilting towards cheaper categories is inherently contrarian as we are often buying what has recently lagged.

Two, we aim to identify Satellite categories which are attractive under the current market environment. Unlike our Core positions, Satellite positions are temporary and may be removed in future years. Satellite investments are stocks or bonds in a smaller, more focused niche than our core funds. For example, a Floating Rate Bond fund would be a satellite fund, whereas an Investment Grade Bond Index fund would be a core position. We select satellite funds with the goal of enhancing returns.

Three, to diversify our portfolios better, we include Alternative investments. We are looking for investments outside of the usual stock and bond categories which might offer an acceptable return, but with low correlation to the risks of stock markets or interest rates. This could include Real Estate, Hedge Fund Strategies, Preferred Stocks, Convertible Bonds, Commodities, Managed Futures, etc. Typically, these provide some ballast when stocks have a Bear Market, so their primary purpose is to reduce risk, rather than to increase return.

Stocks in 2022

Today, we are looking at our investment themes for stocks for 2022; next week we will cover bonds and alternative investments. Needless to say, there is a lot of uncertainty about the stock market going into 2022. As investors, we have to come to terms with the fact that markets do not always provide us with a clear and obvious direction. Uncertainty is the normal state.

No one knows what will happen with the virus or with the Federal Reserve trying to slow inflation without hurting the economy. Those are the two big questions facing stock investors at the end of 2021. However, those are known unknowns. Often, markets are surprised more by the unknown unknowns – the risks we aren’t even considering right now.

Over the past 50 years, the S&P 500 Index was down 12 years, up 37 years, and exactly at 0% in 2011. The 10-year return of the S&P 500 is 16% a year. Being negative on stocks has proven to be a losing bet over time. Yes, you can lose money on stocks and past performance is no guarantee of future results. With that disclaimer, I see no reason to attempt to try to time the market today and withdraw from stocks.

Tilts: Value, International, Small

Here is what I am doing for 2022: weighing relative valuations between stock categories. There are stocks which have gone way up and are probably overvalued. But there are also stocks which have lagged and are relatively cheap. We can break this down three ways: Growth versus Value stocks, US versus International Stocks, and Large versus Small companies.

Growth has lead the markets for more than a decade. As a result, the spread between value and growth categories has widened to historic levels. In fact, the difference today between Value and Growth is equal to what it was during the Tech bubble in 1999. For 2022, we are increasing our tilt towards Value. While we have little in pure Growth funds, we will be reducing our cap weighted index funds, which have become concentrated in Growth names.

US Stocks have led international for a long-time and there is now a wide gap in valuations. US stocks, especially Growth, are expensive. Most US investors have a significant home bias. For 2022, we will shift a small percentage from US to International. We are already overweight in Emerging Markets, and are not adding to our positions in EM.

Small versus Large has been very interesting in 2021. In the US, Small Value has had a great year and looks promising for 2022. US Small Growth, however, lagged Large Growth by more than 20%. In other developed markets, small cap lagged large cap by a small amount. In Emerging Markets, small cap outperformed large cap by more than 20% year to date. There is not a uniform trend here, except that Small Value has done better than Small Growth. In terms of diversifying and looking for cheap stocks, our small cap selection will lean towards value rather than core or growth.

Taxes Matter

We will be making trades to our portfolios for 2022. Even after these trades, a 60/40 portfolio is still going to have about 60% in stocks and 40% in bonds. But the weightings of the positions will change slightly and some of the funds used may change. Our goal is to reduce risk and stay broadly diversified, while using low-cost investments that are transparent and have a good track record.

Throughout the process, we aim for tax efficiency. Changes are easy to incorporate in IRAs and that is always our first choice. In taxable accounts, we harvested losses in March of 2020, which carried forward to 2021. That can also allow us to make some changes without creating additional taxes for the year. And while I could automate the trading process, I am looking at this one client at a time, to do what is best for you, not easiest for me.

Next week, we will discuss our investment themes for 2022 for bonds and alternatives. Then we will be placing trades at the end of December and into January for most clients. I should note that even without making any changes to the portfolio models, we would still be looking to rebalance here at the end of the year. We will do both steps at the same time – rebalancing and any changes to the model – to avoid any unnecessary trades.

I examine investments all year round, but try to limit changes to once a year to avoid short-term trading. Each year, in the fourth quarter, I go through a process of reviewing all our holdings and our allocations. Here is what I wrote last year, looking ahead to 2021: Investment Themes for 2021

Have concerns about your investment portfolio or specific investments? Will your portfolio be sufficient to achieve your goals? How will you transition your accumulation portfolio to spending it down? These are uniquely individual questions and where our conversations can be the most valuable.

Year End Tax Planning 2021

Year End Tax Planning 2021

Let’s discuss some of the key year end tax planning strategies for 2021. It has been a remarkable year with markets soaring, inflation picking up, and the economy booming as we recover from the Pandemic crash last year. A year and a half ago, there were losses everywhere. Now, investors in stocks, real estate, cryptocurrency, and other assets are facing significant gains. Taxes are a major concern.

Here are 10 tax steps to consider before December 31.

Capital Gains Considerations

1. Beware of active mutual funds distributing large capital gains in December. If you have active funds in a taxable account, then make sure you are NOT reinvesting dividends. Better to take that cash and invest in a more efficient ETF or to rebalance.

2. Harvest losses, if you have any for 2021. We harvested losses via tax swaps last year and carried forward tremendous tax benefits into 2021 for our clients. This will help us as we look to rebalance portfolios at year-end.

3. If you are in the 12% tax bracket, your long-term capital gains rate is zero. You can harvest long-term gains and pay no tax. Rather than harvesting losses, you should harvest gains! Then, you can immediately buy back your ETF or fund and reset your cost basis higher. This will help protect you against future taxes. Don’t hold on to gains until future years.

Who is in the 12% bracket? For 2021, this includes single filers with taxable income under $40,525 and married filers under $81,050. Taxable income is after you subtract your standard deduction. So, add back the standard deduction of $12,550 for single or $25,100 married, and you could have gross income of up to $53,075 (single) or $106,150 (married).

4. If you anticipate you will itemize for 2021, bunch deductions as possible before the end of the year.

IRAs and Retirement Contributions

5. If you are able, increase your automatic contributions for 2022. While IRA contributions remain at $6,000 for 2022 ($7,000 if 50+), 401(k) contributions are increased to $20,500 or $27,000 if 50+. Health Savings Accounts are bumped up to $3,600 or $7,200 for a family.

6. Washington wants to eliminate the Backdoor Roth IRA. If you are eligible for 2021, I would do it right away. It may be gone in 2022!

7. Alternatively, if you are in a low tax bracket, consider making Roth Conversions before the end of the year to convert within your low bracket. The key to making this work is making small conversions over many years. Not sure how much to convert? Then let’s talk.

Giving Strategies

8. Even if you do not itemize, you can take an above-the-line deduction for a cash charitable donation of up to $300. For couples, this is doubled to $600. This is only for 2021. In 2022, you will have to itemize to deduct any charitable donation. Above this amount, we suggest donating appreciated securities from a taxable account rather than cash.

9. Consider using your annual gift tax exclusion of $15,000 for personal gifts or for funding a 529 Plan for 2021.

10. If you are 72 or older, don’t forget to complete your Required Minimum Distributions for 2022! Congress waived RMDs for 2020 but they are back this year. If you are over 70 1/2, you can make Qualified Charitable Distributions from your IRA which will count towards your RMD. Be sure to complete any QCDs by December 31.

These are 10 of our top ideas for year end tax planning 2021. I am constantly searching for ways to improve client’s tax situation and add value to their financial planning. I have been getting many new clients this year who are facing large tax bills in the years ahead! Many people aren’t thinking about the eventual taxes as they are building a portfolio or growing a 401(k). And then one day, they realize they have need some help in managing their life in a more tax-wise manner. If that’s you, we can help!

House Hacking

House Hacking

If you are looking to buy a home and want to really grow your wealth, consider house hacking. Our ability to save, invest, and grow real wealth begins with a very simple premise. You have to spend less than you make. It couldn’t be more simple, but that doesn’t make it easy.

For most people, your three biggest expenses are housing, taxes, and cars. If we manage those three expenses well, you may be able to save a significant amount of your income. The more you save, the faster you grow, and the sooner you might reach your goals. Read more: Five Wealth Building Habits

The problem is that most Americans are doing the opposite and creating a lifestyle which consumes 100% of their income. And then there is nothing, zero, left to invest.

House Hacking gives you an incredible opportunity to reduce your biggest expense, in some cases, down to zero. Here’s how. Instead of buying a single family home, you buy a duplex, triplex, or four-plex. You live in one unit and rent out the rest. Your tenants will cover much or even all of your mortgage. You can live there with little or no monthly expenses.

With a house hack, you are freeing up your income so you can save and invest. You can pay off your credit cards. Maximize your 401(k) and Roth IRAs. Start saving for college in a 529. And it’s all because you were willing to live in a multi-family home rather than spending thousands every month on a single family home.

The Details

Sure, house hacking isn’t going to be for everyone. But maybe you want to ask how this might work, if you were to consider it. Although you are buying a multi-family building, you are going to use the house as your primary residence and live there. That means you can still use an FHA mortgage and not have to get a more expensive mortgage for a rental or investment property. With an FHA mortgage, you can put as little as 3.5% down with a FICO score of just 580.

Of course, if you have 20% to put down, you could also do a conventional mortgage as a primary residence. Or, if you’re a veteran, you might be eligible for a VA loan with zero down.

Once you have the property, you can split costs between the area where you live and the area which you rent. This means you can also enjoy some of the tax benefits of being a landlord. Let’s say for example, that your building is 3,000 square feet and you live in 1,200 feet and rent out the rest. You occupy 40% and have 60% as a rental.

Then you can look at your costs, such as insurance, utilities, repairs, taxes, etc. For your bills on the whole house, you can allocate 60% of those costs against your rental income on Schedule E. For the 40% where you live, you can also qualify for the Section 121 capital gains exclusion, when you sell.

Living with other people in the same building might not be your dream situation, but if you can make it work, there could be great benefits for you financially. When you manage your biggest expenses, it becomes easy to have money left over to save and invest. Put your savings on autopilot. Maximize your 401(k). Put $500 month into your Roth IRA to get to the $6,000 annual limit.

Who Can Do a House Hack

House hacking certainly makes sense for a first time home buyer, a single person, or a young couple. That’s probably the typical situation. But it could also work well for older investors who want to turbo charge their savings while they are still working. And if you could reduce your monthly housing cost from $2,000 to $200 or $0 a month, would that change when you will be able to retire? Probably. A house hack might enable you to retire at 55 versus 65. Under the 4% rule, reducing your expenses by $2,000 a month means you now need $600,000 less in your nest egg to retire.

Most of us will resist making a sacrifice to be able to save. Still, if you have an open mind, a house hack might be a brilliant way to save and invest. While your friends and colleagues are barely saving anything, you might be able to put away 50% of your income while your tenants are paying down your mortgage. If you can invest $2,000 a month for 10 years, at a 7% return, you could have $344,000. That might be worth a small sacrifice.

Housing is an expense. Your house should go up in value over time, but the expenses of interest, taxes, insurance, and upkeep are not building your wealth. What if you get someone else to pay for your house? When you reduce those expenses, you are giving yourself a tremendous opportunity to save and invest in appreciating assets. If that is important to you, look for creative ways to cut your biggest expenses!

Have you done a house hack? I’d love to hear from you about your experiences. Send me a note!

Backdoor Roth Going Away

Backdoor Roth Going Away?

Under the current proposals in Washington, the Backdoor Roth is going away. If approved, investors would not be allowed to convert any after-tax money in IRAs to a Roth IRA as of January 1, 2022. This would eliminate the Backdoor Roth strategy and also kill the “Mega-Backdoor Roth” used by funding after-tax contributions to a 401(k) plan.