A tax freight train is bearing down on your retirement. To protect yourself, you'll have to harness The Power of Zero.
Hi there. David McKnight. The Power of Zero show. Welcome to the program. Grateful that you're spending a few moments with us out of your busy, busy schedule. Once again, I'm the best-selling author of The Power of Zero, Look Before You LIRP, and The Volatility Shield. You may have also seen our movie The Power of Zero: The Tax Train Is Coming. If you're looking for our books in bulk, you can go to powerofzero.com/Books. If you want to get our movie DVD/Blu-ray Combo Pack in bulk, you can go to thetaxtrain.com. If you're looking for a Power of Zero advisor, head on over to davidmcknight.com, we’ll find someone in your area that's qualified and that can help shepherd you pass all of those obstacles that stand between you and the 0% tax bracket. Of course, if you are an advisor, we're happy to help equip you to transition your practice to a Power of Zero practice. Head over to powerofzero.com, opt in to our video series, and we will be happy to assist you with that.
Today, one of the things that I’ve been getting asked a lot is what happens to my Medicare Part B premium if I engage in a Power of Zero type strategy? In other words, Dave, you are asking me to do a lot of shifting from tax-deferred to tax-free. In so doing, I am going to increase my taxable income, I'm going to increase my modified adjusted gross income in the year that I do that. Other than potentially paying some taxes that I wasn't planning on paying—I'm preemptively paying some taxes as it were—are there some other consequences for realizing that income in the year that I realize it?
One of the things we've addressed in the past is that when you do a Roth conversion, that does not count towards the income thresholds that determine whether you can do a traditional Roth IRA. We know traditionally if you do a Roth IRA and have $193,000 of modified adjusted gross income, up to $203,000 of modified adjusted gross income, then your contributions to your Roth IRA get phased out. For example, if you're at $198,000 of modified adjusted gross income, you’re 50% of your way through that continuum, that spread of $10,000, therefore, you can only contribute $3,500 to your Roth IRA.
By the way, Roth IRA contributions are not getting adjusted for inflation, they're actually not going up in 2020, they're staying exactly where they are. There are no implications for doing a Roth conversion as far as doing a traditional Roth IRA contribution, however, there actually are some consequences, some implications for your Medicare Part B premium, as well as for your prescription drug premium above and beyond what your current plan causes you to pay.
Let's give you a little bit of background on what people called IRMAA. It’s actually an acronym that stands for Income-Related Monthly Adjustment Amount. This is basically a higher premium charge by Medicare Part B and Medicare Part D to individuals that have incomes that breach certain thresholds. Basically, the way Medicare Part B works is it helps pay for certain services, pays for doctor services, pays for outpatient care, and it covers other medical services such as physical, occupational therapy, and some home healthcare as well. The way this works is—for people with normal levels of income—they're going to pay 75% of that Part B premium. That means, for the average American with normal levels of income, that ends up being $135.50.
However, if you have certain levels of income, particularly those who are taking advantage of the 22% and 24% tax brackets—which is really the main heart of what we're recommending folks to do, if you're in a 22%, convert to the top of the 22%—by the way, 24% is only 2% worse, therefore, you should probably contribute or at least do Roth conversion, shift from tax-deferred to tax-free up to the top of the 24% tax bracket. If you do that, that's going to move you through two different thresholds when it comes to IRMAA repercussions.
For example, if you are a married couple and you have modified adjusted gross income from $214,000 up to $267,000, you are going to pay that standard Part B premium, which is $135.50 plus an additional premium of $135.40. As far as your prescription drug program goes, it depends on which plan you're on. Different people have different costs for their different premiums for their plan so you're going to take your existing plan premium. For the income thresholds, I just stated you're going to add an additional $31.90 per month. All told, we're talking about an extra $170 per month. Maybe around $2,000 per year of additional cost based on you doing Roth conversions that could potentially bump you up into those income thresholds.
If you were to go to the top of the 24% tax bracket, in other words, you had modified adjusted gross income from $267,000 all the way up to $320,000, then that premium is going to be a little bit higher, it's going to go up, for Medicare Part B premium, it's going to be the standard premium plus an extra $216.70. In addition to your plan premium for your prescription drug program, it's going to be an extra $51.40. That's going to be, all told, an extra $270 per month so maybe a little over $3,000 a year.
Now remember the thing to keep in mind is that you are only paying this extra premium in the years in which your income rises through that array of thresholds. It's not like it goes up forever. It goes up in the year in which you breach those thresholds. For a lot of people who are doing say a five-year conversion or a six-year conversion, you would pay that extra $2,000 to $3,000 per year only during the years of those conversions. This, of course, begs the question, is that worth it? Is that enough to dissuade us from doing these conversions? An extra $2,000 to $3,000 that we could have otherwise kept within our retirement plans, grown, and compounded them over time, an extra $2,000 or $3,000 per year for maybe 5 years, is that so much so as to dissuade us from being able to do these Roth conversions? I think the thing that I always try to persuade people is to simply do the math. If what David Walker says comes true and tax rates have to double overtime to keep our country solvent, is it worthwhile paying taxes at today's historically low tax rates, paying that extra $2,000 to $3,000 in the year in which you do those conversions?
Remember, it's only over age 65 if you're planning on doing the conversions. If you're younger than 65, let's say you're 60, and you do it for five years, you're not going to be aged 60, 61, 62, 63, 64, so you had five years there where you don't have to worry about what we're talking about, we're only talking about people that are on Medicare and you are paying a Medicare premium for Medicare Part B. The real question becomes, are you paying so much money so that the math is problematic in the big scheme of things when we do these conversions? I have to remind you, it's like David Walker says, “Tax rates could double overtime to keep our country solvent,” figure out what your tax bracket is, figure out how much additional taxes you would pay where tax rate is to double overtime and ask yourself, is that number more or less than that $2,000 to $3,000 that you could be spending in addition to what you're already spending for Medicare Part B and Medicare Part D which is a prescription drug program?
I think it's really that simple. I don't think that I need to wax on and on and on about this. I think it really is that simple. What's more? You put the $2,000 to $3,000 in your left hand and you add your tax savings in your right hand should tax rates double overtime or it just increased modestly. By the way, do the math and figure out how much greater your tax bill would be were you to simply wait until 2026 and have tax rates revert back to what they were pre-2018 and I think you'll find that your tax bill would most likely go up by more than $2,000 to $3,000. Guess what, if you get that money shifted and you’re over, say, age 65, you get that money shifted before the year 2026, then it really could amount to a wash or you could still be coming out ahead because of how low taxes are today compared to what they'll be in 2026. This is really an easy discussion.
I think people get all up in arms about paying something that they maybe wouldn't otherwise have to pay but you have to recognize that when you get money shifted at historically low tax rates to avoid a potential doubling of tax rates overtime, if you have to pay an extra $2,000 to $3,000 per year only during the year in which you're doing those Roth conversions or maybe you're doing an LIRP conversion, what have you, I think that the math really wins the day. The math really bears out the benefits of what we're talking about in doing this type of planning.
Do I love it that you have to pay a little bit extra for that Medicare Part B premium or for your prescription drug premium? No, I don't love that, but when you look at this in the big scheme of things, I think that we can all recognize that you really will be better off if you can avoid that tax rate train that is bearing down on your retirement plan.
All right, that's the show for today. Once again, I am the best-selling author of The Power of Zero, Look Before You LIRP, and The Volatility Shield. By the way, we're going to have some very exciting announcements coming up after the first of the year so make sure you're staying tuned for that. I'm very excited to make some of these announcements. You want to make sure you subscribe so that you get the podcast on whatever medium you are accustomed to listening to a podcast. You can get a push notification every time we publish a new episode but you gotta make sure that you subscribe in order to pull that off.
Again, you can go to powerofzero.com if you're an advisor and want to learn more. You can go to davidmcknight.com if you are looking for someone to help shepherd you through retirement and get you at or near the 0% tax bracket. It’s not possible for everybody to get to the 0% tax bracket, but we'll certainly do our best to get you at, near, or whatever ultimately makes sense mathematically for your situation. All right, thanks for being on the show and we will look forward to talking to you in a week's time. Talk to you soon.