Don't Let Medicare IRMAAs Be the Reason You Avoid a Roth Conversion

There's a reason Roth conversions are a popular strategy among retirees with large traditional IRA or 401(k) balances. If you keep a substantial amount of money in a traditional retirement account, you'll eventually have to take mandatory withdrawals known as required minimum distributions, or RMDs. Those could drive up your taxes and have other consequences.

To avoid RMDs, you'll need to get your savings out of a traditional IRA or 401(k) and into a Roth. You're allowed to do that at your own pace.

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While IRAs and 401(k)s come with annual contribution limits, there's no limit as to how much money you can convert to a Roth in a single year, or over a short period of time. But doing a large Roth conversion could have financial consequences. Not only might you end up with a large tax bill, you could wind up on the hook for Medicare IRMAAs.

IRMAAs, or income-related monthly adjustment amounts, can increase your Medicare Part B and Part D premiums. IRMAAs are based on modified adjusted gross income (MAGI). The higher yours is, the more likely you are to get stuck paying more for Medicare.

You may be hesitant to do a Roth conversion if it means increasing your IRMAA risk. But in the long run, paying IRMAAs for a year or two could be well worth the savings you'll eventually get to enjoy.

Why IRMAAs shouldn't automatically scare you off

It's easy to see why you'd want to do everything in your power to avoid IRMAAs. IRMAAs can drive up your Medicare costs substantially.

Plus, they feel like a penalty. The only reason you have to pay them is because you have a high income -- not because you're getting extra services out of Medicare. It can feel like a huge blow to pay more than most enrollees for the same level of coverage.

If you're doing a large Roth conversion in a single year or within a few years, your income may temporarily rise to the point where IRMAAs come into play. But that shouldn't stop you from doing a Roth conversion.

Let's say you convert $100,000 from a traditional IRA to a Roth IRA in one year. And let's assume that pushes you into the first IRMAA tier, which adds $81.10 a month to the cost of your Part B premiums and $14.50 a month to the cost of Part D. For simplicity purposes, we'll round this up to $100.

If you're able to convert that $100,000 and stay in the 12% tax bracket, which may be doable depending on your tax-filing status and deductions, you're paying $12,000 in taxes on that conversion. But if you leave that $100,000 in a traditional IRA and withdraw it later when, combined with your Social Security benefits and other income, you're in the 22% bracket, you're looking at $22,000 in taxes.

Now, let's compare that to paying an extra $100 a month, or $1,200 over the course of a year, in Medicare premiums. You're spending that $1,200 to save $10,000.

That doesn't account for additional benefits of having money in a Roth IRA, like getting to enjoy tax-free gains in that account for what could be many years. Plus, with a Roth IRA, withdrawals don't count toward your MAGI. So you may be able to avoid IRMAAs in the future. You might also get out of paying taxes on your Social Security benefits.

Focus on the big picture

While having to pay IRMAAs temporarily may be a sore spot, it's not necessarily a reason to avoid a Roth conversion. Depending on the amount of money you're looking to move into a Roth IRA, IRMAAs could actually end up being a small price to pay for the benefit of having tax-free withdrawals and no RMDs for decades.

Of course, it's still a good idea to plan for conversions carefully. You don't want to move a huge sum of money into a Roth IRA at once if you can help it, since you might end up in a high tax bracket, thereby eroding the savings.

But don't let IRMAAs get in the way of your Roth conversion plans, especially if moving funds into a Roth IRA makes the most sense for you in the long run.

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