Three Financial Traps That Can Be Avoided with Proper PlanningSubmitted by Orange CA Financial Advisor | Sterling Wealth Partners on October 22nd, 2018
Good financial planning involves taking a comprehensive and holistic approach to looking at your financial picture. It isn’t just investment management, but also tax planning, retirement income planning, estate planning, and protection of assets. It also means trying to maximize saving money through tax reduction strategies and expense management. This usually means that we go over your financial plan with a “fine tooth comb” to uncover every area where we can leave more money in your pocket.
Listed below are three “stealth” financial traps that can be avoided or reduced though proper planning. We frequently find that people are surprised when they are subject to one of these traps and didn’t realize that they could possibly have been dodged with proper advice
IRMAA is not the name of a hurricane, but it can certainly wreak havoc on your Medicare budget. IRMAA stands for the” Income Related Monthly Adjustment Amount” and is levied against Medicare premium payors who earn too much money. Most people are unaware that Medicare premiums are calculated on a sliding scale based on your income. For the vast majority of people, Medicare Part B is designed to cover 75% of the premium cost with the participant paying the remaining 25% (currently $134 for 2018). However, IRMAA increases the premiums on a sliding scale based on the latest filed tax return (for example 2016 income for 2018). The sliding scale increases the premium amount the participant must pay and ranges from 35% of the cost up to 80%. People who have modified adjusted gross incomes over $85,000 filing single or $170,000 filing jointly will be subject to IRMAA. There is also an IRMAA increase for Part D prescription drug coverage as well. For example, a single taxpayer making $161,000 per year will pay $503.40 for Part B & Part D coverage. That is a 375% increase over the normal $134 monthly premium!
While it may not always be feasible to plan your income to avoid IRMAA, one important thing to consider is that even exceeding the threshold by $1 causes you to pay the next higher premium level. For instance, a married couple who makes $133,500 will be subject to IRMAA and have a monthly premium of $301.50 each. But, if they make $133,501, their premium now increases $402.50 per person. For this couple, having $1 of extra income costs them $2,424 in increased joint Medicare premiums. This is the kind of thing that can be avoided with proper financial planning.
NII is not a disease, but an additional 3.8% tax applied to your investment income when a certain income threshold is exceeded. NII stands for the “Net Investment Income” tax and is also sometimes referred to as the “Obamacare” tax. Once your adjusted gross income exceeds either $200,000 single or $250,000 married, your investment income (interest, dividends, capital gains, annuities etc.) are subject to the additional tax. The income threshold is not indexed for inflation and stays at this level every year. The tax is applied on the lesser of the actual investment income or the amount your income exceeds the threshold. For instance, if a single person makes $210,000 and has $20,000 of investment income, the NII tax will only apply to the $10,000 over the $200,000 threshold. So, this person would have an extra $380 in tax for that year.
Avoiding NII can be accomplished in two ways:
· Plan your income to remain below the NII threshold.
· Minimize investment income through tax location planning.
Like IRMAA, this is one of those relatively unknown traps that can potentially be avoided through proper tax planning.
The Social Security Earnings Test
Another financial trap to be aware of is the Social Security benefit reduction because of the Earnings Test. This reduction applies to those who start Social Security prior to full retirement age (age 66-67 depending on your year of birth) and continue to work. The “gotcha” is that for every dollar you make above the earnings test, your Social Security benefit is reduced by $1 for every $2 earned over the threshold. For 2018, that threshold is $17,040.
So, consider someone who takes Social Security at age 62 and is receiving a benefit of $1,200 per month. While she wanted to take her benefit early because she was afraid it may not be there later, she also wasn’t ready to retire and kept working earning $30,000 per year. Based on the earnings test, she earned $ 12,960 over the limit, meaning she loses $1 for every $2 of that $12,960. This means her benefit is reduced from $1,200 per month to $528 per month. Once you reach full retirement age, you can earn as much as you like and are no longer subject to the Earnings Test. It only applies if you work prior to full retirement age.
A Social Security analysis done as part of a comprehensive financial plan, could have pointed this out to the client who may have decided that turning on Social Security early was not the right decision.
These are just three of many tax and financial traps that could be avoided with careful analysis and a comprehensive approach to your individual situation.
If you would like a complementary financial review, please contact us.