You have done the right thing for years. You have diligently saved and accumulated funds in your IRA. At some point, the funds that you have put away for years must come out. Uncle Sam wants his share. When you reach age 70 ½, you must take a required minimum distribution (RMD) for that year and for every year thereafter.
You may not be happy about taking RMDs. You may think you don’t need the money, and you may be concerned about the tax hit that the RMD will bring. Besides the RMD itself being taxed, there is a ripple effect when an RMD is taken. An RMD is included as income for the year it is taken. A bump up in your income can negatively affect the availability of deductions and can impact the taxation of Social Security. One significant negative impact of an RMD may be increased Medicare costs. This is often not paid the attention it deserves by many IRA owners until it is too late.
Higher Medicare Costs
Without careful planning, your RMD can result in much higher healthcare costs. This is because the RMD is included in your Modified Adjusted Gross Income (MAGI) used to determine your Medicare Part B and Part D costs two years down the road. You can find the MAGI thresholds for increased costs at https://www.medicare.gov/. You will see there are no phaseout ranges. If you have a MAGI that is $1 over these limits you will have to pay the full extra amount. This can be a significant amount.
How can you avoid falling into the trap of higher Medicare costs? Here are two strategies to consider:
If you are in your early sixties you may want to consider converting to a Roth IRA sooner than later. You will want to get the conversion done before the income from the conversion would affect your MAGI for Medicare purposes. By doing so, you can minimize the impact of RMDs on Medicare costs. RMDs are not required from Roth IRAs during the Roth IRA owner’s lifetime and qualified Roth IRA distributions are not included in MAGI for Medicare purposes.
If you are already taking RMDs, a Qualified Charitable Distribution (QCD) is another strategy you may consider to minimize the impact of RMDs from an IRA on Medicare costs. With a QCD, you can transfer up to $100,000 annually from your IRA to a charity tax-free.
A QCD can satisfy your RMD for the year and it is not included in MAGI for determining Medicare costs. Keeping the RMD amount out of MAGI can result in big savings. This is not the case if you take your RMD and then donate to a charity and claim a charitable deduction. With that approach, the RMD would still be included in MAGI.