The 401(k) Move at 63 That Can Raise Retirees’ Costs Later

If you plan to make a sizable 401(k) withdrawal for a major expense or move pretax savings into a Roth account, you probably already expect an income-tax hit. But there may be another delayed expense that can quietly strain a retirement budget later on.

That kind of cash move is not automatically a mistake, but it does call for careful planning. The timing and amount can matter more than many savers realize.

Your Medicare bill looks back two years

Income-related monthly adjustment amount, or IRMAA, is an extra premium charged to higher-income Medicare beneficiaries. It is not technically a penalty, but it can certainly feel like one when the bill arrives.

Social Security can decide that you owe income-related surcharges for Medicare Part B and Part D, and it generally bases that calculation on tax information from two years earlier. That means income in the year you turn 63 can affect the premiums you pay in the year you turn 65, something many people do not factor in when shifting money around.

So even if a 401(k) withdrawal was spent long ago on an urgent need, it could still lead to higher Medicare premiums two years later.

Every dollar matters

The standard Part B premium for the relevant year is $202.90 a month, but surcharges begin above $109,000 for individual filers and $218,000 for married couples filing jointly. Once you cross a threshold, you owe the full surcharge for that tier; it does not phase in like a marginal income-tax bracket. For example, a single filer with $109,001 in modified adjusted gross income crosses the first threshold.

For someone enrolled in both Part B and Part D, the first tier adds $81.20 for Part B and $14.50 for Part D, or $95.70 a month and $1,148.40 a year. Those charges come on top of the regular premiums you already pay. And if both spouses are on Medicare, each person can owe a separate surcharge based on joint income.

The highest-tier surcharges are even steeper, at $487 a month for Part B and $91 for Part D, per person.

More than retirement income counts

Although 401(k) withdrawals are the focus here, they are not the only way to trigger the surcharge. Medicare uses modified adjusted gross income, or MAGI, which equals adjusted gross income plus tax-exempt interest.

That figure is usually higher than taxable income after the standard deduction or itemized deductions.

What counts?

Taking pretax money out of a traditional retirement account such as a 401(k), or converting that money to a Roth, generally increases the income Medicare uses to set premiums. Those transactions are different from a tax-free rollover into a traditional IRA or a qualified withdrawal from an existing Roth account.

Other items that can raise MAGI include capital gains from taxable investments or property sales. The sale of a primary home may keep some or all of that gain out of income. Tax-exempt interest also counts in Medicare’s calculation, even though it does not count for income-tax purposes.

A Roth conversion can still make sense

This Medicare issue does not mean retirees should avoid conversions altogether. There may be a sizable window after retirement and before required minimum distributions begin, when annual income is much lower and a conversion can make sense.

Paying tax on conversions now can reduce future pretax balances and shrink later required distributions, which may help lower future income-related premiums.

Spread out conversions and time carefully

If you convert smaller amounts over several tax years, you may be able to keep any one year’s income from getting too high for Medicare’s later calculations. It helps to use annual income estimates as a planning tool instead of targeting one exact number.

Review expected wages, retirement distributions, investment gains, and interest, then compare your estimated MAGI with the current thresholds as a conservative guide. The thresholds that apply two years later may be different. From there, choose a conversion amount that leaves room below the level you want to avoid.

If needed later, consider giving some away

Qualified charitable distributions can be an option later in life for people age 70½ and older, rather than a strategy available at age 63. An eligible QCD goes directly from an IRA to a qualified charity and can keep otherwise taxable IRA distributions out of Medicare’s income calculation for that year. It does not reverse income from an earlier withdrawal or Roth conversion.

This is an IRA strategy, not a direct charitable withdrawal from a 401(k), but it can satisfy some or all of an IRA required minimum distribution when those rules apply.

Bottom line

A large withdrawal or conversion can affect both your current tax bill and future Medicare premiums. The point is to coordinate size and timing, not necessarily to avoid conversions entirely.

If your income drops after a qualifying life-changing event, such as retirement or reduced work, you can ask Social Security to use more recent income information. Form SSA-44, along with supporting documentation, can be used to request a new determination that better reflects your current retirement situation. A one-time withdrawal or Roth conversion by itself is not a qualifying life-changing event.

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