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Watch Out For The Gift Of The MAGI

34544904 - christmasA couple of weeks back, Jack came to see me. Jack is married to Sandy, and they have three grown children. Jack is a pretty smart guy. He retired as the director of financial planning at a large aerospace manufacturing company, having earned and saved quite a bit.
 
After retiring, Jack was asked to work in a consulting capacity as an independent contractor for his former employer, still earning a healthy income of about $108,000. Jack and Sandy just moved to Falmouth, are faithful Cutter Family Finance readers, and like most, are looking for ways to create the best retirement system. In our meeting, Jack expressed a deep concern for how much he and his wife are paying for their Medicare benefits and asked if there is anything they could do to lower the premium they are paying.
 
Hmmm . . . let’s take a look.
 
We all grew up on fables, right? You know the ones: where we witness many of the important life lessons right there in a storybook. I think about the importance of fables each time I see mention of the “The Gift of the Magi.” For those who haven’t read it, “The Gift of the Magi” is a short story by O. Henry about a young married couple and how they deal with the challenge of buying secret Christmas gifts for each other with very little money. It’s a wonderful, sentimental story with a moral about love, sacrifice and gift-giving. But, as a financial advisor, I see it as a pretty clear story of managing your money to get the most bang for your buck.
 
This year, many upper-income Americans on Medicare might experience what I am calling, “The Gift of the MAGI (Modified Adjusted Gross Income).”
 
Last year, nearly 2 million Americans owed higher premiums than the average American for drug coverage on Medicare Part D, and more than 1 million more owed higher premiums for Part B, which covers doctors’ visits and other specified “medically necessary services.”
 
The Medicare program is designed to charge the top 5 percent of income earners a higher premium than everyone else covered under the program. The base annual premium for Part B coverage is $1,462 for the average American. However, for those “super rich” folks who show income over $85,000 for a single filer and $170,000 for a couple, well, their surcharge for Part B ranges anywhere from about $600 to $3,400 bucks a year.
 
And it gets worse. In the coming years, for at least a portion of that group, Congress has changed the rules again, starting in 2018. According to the Kaiser Family Foundation’s 2016 Medicare Trustees Report, individuals earning more than $85,000 but less than $107,000, may see their combined annual Part B premium jump from $1,462 to $2,089, about a 30 percent increase. And if you earn $1 (literally) over the $107,000 your premium jumps to $2,984, a 52 percent increase. And who is to say that Washington won’t mess with those income thresholds as Medicare gets deeper and deeper into debt?
 
What makes matters worse is that the specified income levels are not adjusted for inflation each year; so as inflation rises, and income levels rise, the percentage of people on Medicare who will owe surcharges will rise as well.
 
But there is hope for Jack and others, which brings me to what is sure to be a famous tale “The Gift of the MAGI (Modified Adjusted Gross Income).”
 
For those who don’t know, Modified Adjusted Gross Income is a person’s Adjusted Gross Income (AGI), plus any tax-exempt interest income added back. You can find your AGI on the front page of your 1040 form, line 37, down at the bottom of page 1. It’s important for you to know what goes into this number, because it is this number that is the most significant factor in determining how much you pay for your Medicare benefits. So items that fall “below” this line (technically, on page 2), items such as charitable donations, mortgage interest, and property taxes, that can lower your taxable income, do not lower your AGI, and therefore do not lower your MAGI either.
 
So let’s talk about how to keep this ever important MAGI figure down.
 
Jack and Sandy gave $15,000 to various charities last year. But they wrote checks for those gifts, resulting in “below the line” deductions, which, as I just explained, cannot be counted as deductions for purposes of the MAGI calculation. So, I explained to Jack that there are ways to give that will lower the MAGI. For example, if he gifts appreciated assets, such as shares of stock, instead of selling them to make a cash donation, then we have just re-classified the deduction from a “below the line” deduction to an item that will lower their MAGI. This is because they will not need to include the capital gains from the sale of that stock in their Adjusted Gross Income. As I tell my kids, it is the little things that make the biggest difference.
 
I also explained to Jack and Sandy that the same can be done with giving directly from an IRA. The IRS allows us to withdraw up to $100,000 a year from an IRA, tax-free, to donate to charity. And if you are over the age of 70 ½, this donation can be counted toward your Required Minimum Distribution (RMD). There are certain rules that must be followed; for example, the distribution must go directly to the charity from the IRA, so please consult your retirement specialist.
 
This is also another situation where you will be hearing me praise the value of a Roth IRA. Because of the tax advantages of a Roth, being pre-taxed, the payouts are not taken into account in your AGI. Conversions from a traditional to a Roth, on the other hand, will raise that income figure for that taxable year.
 
Since Jack is technically self-employed, I also suggested he consider opening a Solo 401(k) or a SEP-IRA. This vehicle allows an individual to defer up to $53,000 of taxable income, thereby lowering AGI. Additionally, since Jack is self-employed, he should look into whether he can deduct the premiums. Oftentimes the self-employed can deduct Medicare premiums as a health insurance cost.
 
In the end, those small changes could make a significant impact on Jack and Sandy’s cost of Medicare, lowering their premiums by about 50 percent.
 
And that, my friends, is the gift of the MAGI.
 
Be vigilant and stay alert, because you deserve more!