Social Security & Medicare Tax Planning Strategies

April 02, 2024

Retirees face the reality that their Social Security benefits are subject to taxes, often up to 85% based on income level. Additionally, with the elimination of the stretch provision for inherited IRAs and overall costs continuing to rise, Medicare premiums are bound to increase. Despite appearing insignificant, these accumulated hidden costs can significantly impact retirees' finances over time. Here are strategies to manage the tax implications and rising Medicare premiums within a broader retirement planning picture: 

Understanding Social Security Taxation Thresholds:

  • For single filers, Social Security benefits are taxed once total income exceeds $34,000.
  • For married couples filing jointly, taxation begins when their combined income surpasses $44,600.
  • It's important to note that these thresholds remain unchanged since 1984 and were not indexed to inflation. Additionally, understanding the meaning of "MAGI" (Modified Adjusted Gross Income) is crucial for effective tax planning.

Strategic Moves for Tax-Efficient Retirement:

  • Prioritize Roth Contributions During Your Working Years:
    • While you're still earning, consider prioritizing contributions to Roth IRAs or Roth 401(k)s. Qualified withdrawals from Roth accounts are tax-free, meaning they won't impact your MAGI and, consequently, won't lead to higher Medicare premiums or taxes on your Social Security benefits down the line. This strategy helps you build a tax-advantaged nest egg that won't trigger hidden tax consequences in retirement.
  • Deplete Beneficiary IRAs Before Medicare: 
    • Strategically deplete funds from inherited Beneficiary IRAs before the two-year window leading up to Medicare While this may result in short-term tax implications, it can save thousands of dollars on Medicare premiums early in retirement.
  • Spread Out Distributions from Retirement and Taxable Accounts Alike: 
    • Similar logic applies to withdrawals from your traditional IRAs and other taxable accounts such as Trusts. Avoid concentrating withdrawals in a single year from any one account type. Instead, spread them out strategically over multiple tax years to help with income smoothing. Depleting a Trust account too quickly will lead to higher taxable distributions from retirement accounts later in retirement.
  • Consider Roth Conversions for Existing IRAs: 
    • If you have a significant balance in a traditional IRA, consider converting some or all of it to a Roth IRA. While there will be tax implications for the converted amount in the year of conversion, future qualified withdrawals from a Roth IRA won't be taxed.

While taxation on Social Security benefits and increased Medicare premiums may be unavoidable, awareness of these considerations can help reduce the taxable ramifications of distributions early in retirement. We generally believe in optimizing taxes over rolling 3-5-year periods rather than focusing on tax savings in a single year, which may cause income and taxes to spike in subsequent years. Understanding these ramifications and the treatment of distributions will help optimize tax planning strategies year over year.