Ready For Retirement
Ready For Retirement
The Hidden Cost of Roth Conversions: Avoiding Surprise Medicare Charges
Roth conversions can save thousands in taxes, but they can also trigger Medicare IRMAA surcharges that quietly add up to more than $5,000 a year. Most retirees never see it coming, because the rules for Medicare premiums don’t line up with the tax brackets everyone focuses on.
In this video, James breaks down how Roth conversions interact with Medicare Part B and Part D premiums, why modified adjusted gross income matters more than taxable income, and how crossing a threshold by even one dollar can change your costs for an entire year. The case study shows how a couple could save nearly a million dollars in lifetime taxes… but lose tens of thousands to unnecessary IRMAA charges if they convert without a plan. A small adjustment (converting up to the right tier instead of the wrong bracket) boosts their long-term wealth and avoids surprise premiums.
If you’re planning Roth conversions before RMDs begin, evaluating a 401(k)-to-Roth strategy, or trying to minimize taxes in early retirement, understanding Medicare thresholds is essential. A smart conversion plan balances tax savings with premium costs so you don’t give back what you worked so hard to save.
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The strategies, case studies, and examples discussed may not be suitable for everyone. They are hypothetical and for illustrative and educational purposes only. They do not reflect actual client results and are not guarantees of future performance. All investments involve risk, including the potential loss of principal.
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Most people think Roth conversions are a smart tax move, and they are, until you realize they can add thousands of dollars per year to your Medicare premium. That's why today we're gonna talk about how a well-intentioned tax strategy may backfire on you if you're not careful about how you're implementing it. To illustrate this, I'm gonna take you right to a case study that shows how Medicare premiums went from zero dollars per year of excess premiums all the way up to over$5,200 per year of extra premiums unintentionally. Someone thinking they were implementing the right tax strategy, but in doing this, it ended up costing them thousands of dollars per year and tens of thousands of dollars over the course of their retirement. Now, this might seem fairly complex, but I'm gonna break it down for you in a very simple way to understand so that as you start implementing your Roth conversion strategies, you can get the benefits both of ordinary income tax brackets as well as being mindful of IRMA surcharges that could cost you thousands of dollars per year. So let's take a look at this worksheet here. This shows you important numbers to know for 2025. These numbers will be adjusted up for 2026. But the important thing to understand is this most people, when they're looking at doing Roth conversions, are only focused on these numbers right here. They're looking at federal ordinary income tax brackets. And what you can see here is those tax brackets range from 10% all the way up to 37% and the highest. Typically, the strategy is how do we fill up those lower tax brackets, maybe 10, 12, even 22% to avoid paying taxes at a later date at 24% or higher. Now, if all you're doing is this, you're missing a big part of the picture. Because what I want to call your attention to now is this. What you can see here is this is what your IRMA surcharges or your Medicare premium surcharges are based upon. If you are married filing jointly, you can see here's what your modified adjusted gross income needs to be in order to have these surcharges. So Medicare Part B and part D, there's no additional surcharge if your income, your modified adjusted gross income, I'm gonna explain why that's so important in a second, is$212,000 or less. Or if you're single, if it's$106,000 or less, your Part B and Part D premiums, you do not have any extra surcharge. However, as soon as you cross even$1 over this threshold, your new monthly surcharge for part B is$74 and part D is$13.70. So those are combined amounts that every single month you will pay for the year in which your income was about that amount. Now, here's the detail that gets people tripped up. And if you know this, it could be the difference between tens of thousands of dollars saved for a very simple understanding of how this works. When you look at these numbers here, they are based on modified adjusted gross income. When you look at these numbers right here, these are based on taxable income. So what's the difference? Well, your modified adjusted gross income, this is your total income before you take any deductions. It's a little bit more complicated than that, but generally speaking, your modified adjusted gross income is gonna be the income you have before you take a standard deduction or before you take an itemized deduction. It's also gonna have a few other things added into it. But generally speaking, if you have, for example, a modified adjusted gross income of 212,000, your taxable income is going to be lower. Here's why that matters. You might look at this and say 212,000, that's not a big deal because I was planning. So I'm married, I'm filing jointly, I was planning to convert up to the 22% tax bracket. And the 22% tax bracket, that's at$206,700. So I'm already expecting to come under that$212,000 number that my Medicare surcharges are based upon. Not so fast, because remember, if your taxable income is$206,700, your modified adjusted gross income is at a minimum$30,000 higher than that, simply due to standard deductions. So this can cause people to think if all I do is convert up to the 22% tax bracket, I'm avoiding Medicare surcharges. Now I know that's a ton of numbers. So let me show you an illustration, a visual of how that actually plays out. And I'm gonna use Michael and Lisa as sample plan to illustrate this. Here's their assets. They have a lot of money in pre-tax accounts, Michael's 401k, Lisa's IRA. They know that taxes are going to be an issue if they don't start converting those assets to their Roth IRAs. Now here's the problem. As I mentioned, is most people are only looking at the ordinary income tax brackets. And when they look at this, they can see how impactful this can be. So, for example, if they want to fill up the 22% ordinary income tax bracket, right off the bat, we can see that that strategy of converting money from their 401ks and IRAs into their Roth IRA, that's going to result in$975,000 fewer dollars paid in federal income taxes. That's a huge win. Most people stop there, but they're still leaving lots of money on the table. If I go to this page right here, what you can see is in order for them to do that, they are converting, so they're pulling money from their IRAs to their 401ks in these years where their taxable income is expected to be much lower. So instead of paying 0% taxes, because maybe in these years here, between 65 in this example and 70, they're in a much lower tax bracket. Instead of just enjoying that and keeping taxes low, they're smart. They're starting to pull money from IRAs and move it to Roth IRAs and fill up the 10%, the 12%, the 22% tax bracket. What you can see here is that proposed strategy results in over a million dollars in tax adjusted ending assets. I know this number is different than the number we just saw. We're looking at two different things. One is actual dollars saved, one is the difference in tax adjusted ending wealth. So some nuances there and what those two numbers mean, but the bottom line is both of them are positive. Now here's the thing. As I mentioned before, when we looked at that worksheet, converting up the 22% tax break, it doesn't seem like it's going to cause your Medicare surcharges to spike, but it will because Medicare surcharges are based upon modified adjusted gross income. Ordinary income taxes are based upon your taxable income. Two different things. So if instead we are a little bit more strategic about that, and looking at these years here, this yellow line here, this represents the top of the 22% bracket. What if we said we don't actually want to convert up to the top of the 22% bracket? We want to convert up to the point at which we're going to be pushed into a different tier. So in this example, we can say, how much can we convert before triggering any IRMA surcharges? Just as a reminder, here's what those numbers are again. If you're married finally jointly, under 212,000. If you are single, under 106,000, no IRMA surcharges. Here's tier one, here's tier two, here's tier three, four, and five. And you get progressively higher IRMA surcharges the higher you move up in that. So this is that threshold, no IRMA surcharges. Just for the sake of comparison, this is the one, this tier one is most closely approximated to the 22% tax bracket. If I look at this, so keep in mind, so far, this couple's adding$1,057,000 to their tax adjusted ending wealth. If I change this, what you're gonna look at is now all of a sudden, just by making that one change, there's an additional$90,000 of tax adjusted ending wealth. And here's why, and here's why the benefit isn't even fully stated here. What you can see here is now all of a sudden they're not converting all the way up to that 22% tax bracket. The 22% tax bracket for ordinary income might be here, whereas that tier one Irma surcharge might be here. So they're only converting up to that, which means they're saving a few thousand dollars per year they ordinarily would have been paying. And the better news is Roth conversions hurt. We see the tremendous value that they have, but they require converting lots of money, which means paying lots of taxes earlier than you ordinarily would have done so. So if by doing this, not only are you gaining tens of thousands of extra dollars, you're also allowing yourself to pay less in taxes in those earliers to do so, that becomes a win-win. So, in doing this, the Roth conversion strategy is very important. It's helpful, but a simple adjustment, something that actually feels better, that works better in the short term, and also leads to better results long term. That cannot be overstated. Now, as you're watching this, these numbers aren't gonna be your numbers. If you want to run your projections with this, you can get access to the same software in the Retirement Planning Academy. Link is in the show notes below. But the important thing to realize here is Roth conversions are powerful. In the ordinary income tax brackets, that's typically gonna be the single largest driver determining how much should you do in Roth conversions. But if you're not careful, you're gonna miss some of the low-hanging fruit. You're gonna miss some of these things that might actually allow you to convert less and gain more. The value of that, that low-hanging fruit, simply by knowing what not to do, could be the difference in tens of thousands of dollars. So, what are those things you need to look at? Well, quite simply, ordinary income tax brackets, as you can see right here. That's the 10, 12, 22, 24, so on and so forth. Capital gains tax brackets. Capital gains have three tax brackets: 0%, 15%, and 20%. Understanding the impact of what you're doing with Roth conversions, how is that impacting what your qualified dividends and long-term capital gains, what rate are they being taxed at? So you can't do Roth conversions in a vacuum. You need to understand as you're doing those over here, is it simultaneously pushing qualified dividends and other long-term capital gains into a different tax bracket? And then finally, Medicare premium tax brackets. As we see right here, these Medicare premiums, they can be quite substantial. Now you might look at this and say, my income is not going to be that high in retirement. Might be if you're doing serious Roth conversions. Depending on the balance of your pre-tax accounts, depending on your strategy, you might not be earning that much or even spending that much, but there may be some years where your income certainly is in these levels because of the tax strategy that you're implementing. And by the way, if you want any help implementing this, this is exactly what we do at Root Financial. You can scan the QR code right here or click the link to our website in the show notes below to schedule a time to speak with one of our advisors. But this is so important. Your tax strategy could be the difference in hundreds of thousands or millions of dollars over the course of your retirement. And when you understand that Roth conversions aren't only based upon what your ordinary income tax brackets are expected to be, but they also have to do with capital gains tax brackets, IRMA surcharges, even taxation of Social Security. You start to understand how one thing you do with Roth conversions here has ripple effects across everything else. So get this right, and it starts by understanding what impact does a decision over here have on everything else. Once you know that and how that impact is calculated, you can make the right decision that leads to the best possible retirement outcomes for you.
