Medicare and budgeting for future medical expenses are important elements of personal financial planning. Sometimes, controlling Medicare premium costs is overlooked and estimating future medical out-of-pocket expenses is understated. Accordingly, this article focuses on Medicare planning issues that CPA financial planners should consider when advising clients. These issues include an overview of Medicare taxes, the determination of premium surcharges, projected future health care costs, and strategies to mitigate the impact of the escalating Medicare charges paid by many higher-income clients.
Medicare has been enduringly popular since it began in 1966. It provides health insurance to Americans over age 65 and to many younger people with disabilities and certain illnesses. For most of the history of Medicare, everyone paid the same premiums. There was no "means testing." However, since 2007, as a result of the Medicare Prescription Drug, Improvement, and Modernization Act of 2003, PL. 108-173, people of certain income levels have been required to pay surcharges for Part B of Medicare (outpatient medical coverage). Under the 2010 Patient Protection and Affordable Care Act, PL. 111-148, those same individuals may also pay more for prescription drug coverage under Part D. The Medicare Access and CHIP Reauthorization Act of 2015 (MACRA), PL. 114-10, increased the cost of Medicare for higher-income beneficiaries starting in 2018. The aim of MACRA is to significantly increase premium revenues moving forward.
The median traditional Medicare health care costs (premiums, co-pays, and out-of-pocket expenses) for a person age 65 in 2019 are estimated to be $5,160 (Guide to Retirement, J.P. Morgan Asset Management, 2019, page 31, available at tinyurl.com/yyrxwnoe). The annual health care cost inflation rate is 6.5%. This implies that median health costs, which include Medicare premiums and surcharges, for a person age 85 in 2039,20 years from now, can be estimated to be $18,180 from inflation alone, not taking into account the likely higher medical costs related to aging. The base Medicare premium for 2019 is $135.50 per month. Surcharges are imposed on beneficiaries with higher income: single taxpayers with modified adjusted gross income (MAGI) in excess of $85,000 and married couples with MAGI greater than $170,000. A single retired individual earning $110,000 in 2019 will pay additional premiums (surcharges) of $2,008 and have estimated annual current median health care costs of $7,168.
A married couple with retirement income of $325,000 will pay additional premiums of $4,426, and their annual current median health care costs are estimated to be $9,586 (Guide to Retirement, page 31). Health care costs for retirees are substantial and increasing faster than the average conventional inflation rate; these costs definitely need to be considered when doing prudent financial planning. Increasing Medicare surcharges make it very important for affluent individuals to engage in proactive tax planning.
MEDICARE ALPHABET SOUP
There are two plan choices for Medicare: traditional Medicare or Medicare Advantage. Individuals (and their spouses) who have paid Medicare taxes for 40 quarters are eligible for Medicare at age 65. Disabled individuals have different eligibility rules; consult the Medicare.gov website for the details. Medicare has basically four parts:
Part A: Inpatient hospitalization, premium-free;
Part B: Doctors, tests, and outpatient hospital insurance;
Part C: Medicare Advantage, an alternative to Parts A and B and, often, Part D; and
Part D: Prescription drug insurance.
If clients don't sign up for Parts B and D at the right time (eligibility starts at age 65), they may be subject to significant permanent lifetime penalties, and late filing can leave them with no primary health insurance. Individuals are not required to sign up for Medicare Parts A, B, and D if they have other "creditable coverage" such as through an active group health insurance plan. Regardless of other coverage, however, recipients of Social Security benefits at age 65 or older must take Part A, for which they pay no premium.
Medicare taxes are assessed on earned income (wages and self-employment income). The Medicare tax on wages is paid by both employees and employers at a rate of 1.45% on 100% of wage income. There is no exclusion for income over a salary base as is done with Social Security taxes. Self-employed individuals pay both the employee and employer portions of the tax (2.9%) on their net self-employment income. An additional 0.9% Medicare surtax is levied on wages and/or self-employment income above $250,000 for married individuals filing a joint return, $125,000 for married individuals filing a separate return, and $200,000 in any other case.
Taxpayers may also be required to pay the net investment income tax, which is the equivalent of a Medicare tax on investment income that is subject to the tax. The Sec. 1411 net investment income tax was enacted by the Health Care and Education Reconciliation Act of 2010, P.L. 111-152, which gave it...