As I noted in my previous article, converting the maximum amount each year into a Roth IRA that keeps you in the same tax bracket will increase your wealth over the long term, especially if you pay the extra taxes from cash instead of IRA funds. If you are like most people who will be paying Medicare Part B premiums at age 65, however, you want to be sure that your Roth conversions do not increase your Modified Adjusted Gross Income to a level that causes you to pay higher Medicare Part B premiums.
How do Roth conversions affect health care costs?
Your Medicare Part B premiums for any given year depend on your Modified Adjusted Gross Income from two years ago. The higher your income, the higher your premiums. Medicare begins at age 65, which means the year you turn 63 is the year you have to worry about Roth conversions affecting your Part B premiums. The amount you convert from a traditional IRA to a Roth IRA is added to your income for that year, which could cause you to pay higher Medicare Part B premiums two years later if you convert too much. Consider the following chart.
In 2016, you would pay $1,462 a year for Medicare Part B coverage if you were married and had a Modified Adjusted Gross Income in 2014 of no more than $170,000. If in 2014 you had gone just one dollar over $170,000 because of a Roth conversion, your annual Medicare Part B costs would have increased to $2,046 in 2016. If your Modified Adjusted Gross Income had gone over $214,000 in 2014, your Part B costs this year would have increased to $2,923. Ouch!
The tax benefits from a Roth conversion start out small and compound over time, while any increase in Medicare Part B premiums is immediate. No matter how confident you are that the amount you want to convert to a Roth IRA will not cause your Medicare Part B premiums to increase, you cannot estimate what your Modified Adjusted Gross Income will be with high confidence until the end of the calendar year. What if you get an inheritance, win the lottery, or sell stocks for a large capital gain late in the year?
If I had to pay Part B premiums, I would wait until late December to estimate how much I could convert to a Roth IRA without triggering higher Medicare premiums. I also would convert less than the maximum just because estimates are not precise.
- If you are fortunate enough to retire before age 63, your Roth conversions will not affect Medicare until the year you turn 63.
- If your income is low enough to qualify for an Obamacare health insurance subsidy, I see no reason to bother with Roth conversions. A conversion would cause your income to increase, putting you at risk for losing your subsidy.
What if I need the money now?
The strategy in my previous article was devised for people who hope not to have to use their IRA funds for many years, if ever. Many retirees either need money from their IRAs for living expenses or for large one-of-a-kind expenses like a new roof or a new car. For most people in this situation, Roth conversions are of little or no benefit.
The money withdrawn from a traditional IRA to pay expenses will add to your taxable income. This leaves less room for additional taxable income that would result from a Roth conversion before you either cross into a higher tax bracket or pay more for Medicare Part B coverage.
What should I do if I'm still confused?
CPAs and tax advisors know a lot about these issues, so check with them first. Even if you are confident in what you plan to do, they can help with some of the details. At a minimum, the articles you read on Seeking Alpha regarding Roth conversions should make you smarter and help you to ask the right questions when talking to a tax expert.
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