How Roth Conversions Can Impact Your Medicare Premiums

You’ve been diligently saving for retirement in your traditional 401(k) or IRA, but have you considered the potential benefits of converting some of those funds into a Roth account? A Roth conversion can be a savvy move for certain individuals, as it allows you to pay taxes on the converted amount upfront, leaving your future withdrawals tax-free in retirement. However, it’s crucial to understand how a Roth conversion could affect your Medicare premiums and potentially increase the taxes you pay on your Social Security benefits.

What is a Roth Conversion?

A Roth conversion involves transferring funds from a traditional tax-deferred retirement account, such as a 401(k) or traditional IRA, into a Roth account, like a Roth IRA or Roth 401(k). The key difference is that you pay taxes on the converted amount in the year of the conversion, rather than when you withdraw the funds in retirement.

How Roth Conversions Can Affect Medicare Premiums

While the potential long-term tax savings of a Roth conversion can be enticing, there’s a catch for those nearing or in retirement age: the converted amount is considered taxable income in the year of conversion, which could temporarily push you into a higher income bracket. This, in turn, could trigger higher Medicare premiums.

Medicare premiums are based on your modified adjusted gross income (MAGI) from two years prior. For example, your 2023 Medicare premiums would be determined by your 2021 MAGI. If a Roth conversion in 2021 significantly increased your MAGI for that year, you could face higher Medicare Part B and Part D premiums in 2023.

The table below illustrates how your MAGI affects your Medicare premiums for 2023:

Impact on Social Security Benefits

In addition to potentially higher Medicare premiums, a Roth conversion could also increase the taxes you pay on your Social Security benefits. The Internal Revenue Service (IRS) includes Roth conversion amounts as part of your provisional income when determining if you’ll owe taxes on your Social Security benefits.

If your provisional income exceeds certain thresholds, up to 85% of your Social Security benefits could become taxable. The thresholds are:

• Up to 50% of your benefits are taxable if your provisional income is between $25,000 and $34,000 for individuals ($32,000 and $44,000 for married couples filing jointly).
• Up to 85% of your benefits are taxable if your provisional income exceeds $34,000 for individuals ($44,000 for married couples filing jointly).

Strategies to Minimize the Impact

While Roth conversions can have consequences for your Medicare premiums and Social Security benefits, there are strategies to minimize the impact.

1. Partial Conversions: Instead of converting your entire traditional retirement account balance in one year, consider spreading the conversions over multiple years. This can help keep your MAGI below the threshold for higher Medicare premiums and reduced taxation of Social Security benefits.

2. Timing: Carefully time your Roth conversions to coincide with years when your income is lower, such as the year you retire or during a gap between jobs.

3. Utilize Tax Brackets: Work with a financial advisor to identify the optimal amount to convert each year, staying within the lower tax brackets and avoiding pushing yourself into a higher marginal tax rate.

4. Consider Other Income Sources: Be mindful of other sources of income, such as withdrawals from non-retirement accounts or rental income, which could further increase your MAGI and potentially trigger higher Medicare premiums or taxation of Social Security benefits.

5. Undo the Conversion: If you find that the Roth conversion has pushed you into a higher tax bracket or increased your Medicare premiums more than anticipated, you may be able to “undo” or recharacterize the conversion by the due date of your tax return (including extensions).

While Roth conversions can be a valuable retirement planning strategy, it’s essential to understand the potential impact on your Medicare premiums and Social Security benefits. By carefully planning and implementing the right strategies, you can maximize the benefits of a Roth conversion while minimizing any unintended consequences.