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It’s not up for debate, smoking is bad for you. It leads to cancer, harms every single organ in the body and has become somewhat expensive as well, but when planning for retirement you may be, believe or not, better off smoking than investing into a Traditional IRA or 401(k).

Sounds ridiculous, we know, but with the understanding of federal regulations and your health coverage in retirement it will become increasingly apparent that investing into any tax deferred investment is just really bad for you.

The federal regulations that you must know about:

  1. You must enroll into Medicare to receive any Social Security benefit.
  2. This mandatory health coverage (Medicare) is based on your income through Medicare’s Income Related Monthly Adjustment Amount (IRMAA).
  3. The cost of this coverage is automatically deducted from your Social Security benefit.
  4. Income, by definition of the federal government, is “your adjusted gross income plus any tax-exempt interest you may have or everything on lines 37 and 8b of your 1040 tax return.
Some examples of income that counts towards IRMAA are:

Social Security benefits, Wages, Rental and Pension Income, Interest, Capital Gains, Dividends and all distributions from any tax-deferred investments you may have. This includes your traditional 401(k).

By investing into that traditional 401(k) you are setting yourself up for higher health costs, as well as receiving a lower Social Security benefit.

The tax benefits today of investing in a taxed deferred vehicle will be, if you live an average life span, negated, thanks, in part, to Medicare’s IRMAA.

But will you be impacted by this?

Thankfully, the federal government pegged the IRMAA brackets at a high level which start at $85,000 in income for a single person and $170,000 for a couple so this shouldn’t impact too many people.

An example of who the federal government is eyeballing for Medicare’s IRMAA:

Person A is:

  • 55 years old today and retiring at age 70.
  • Is investing $10,000 a year into that traditional 401(k) annually at a 5 percent return.
  • Has saved $50,000 in that traditional 401(k) already.
  • Earns $85,000 a year from employment.

The good news, by age 70, Person A:

  • Will have saved $40,000 in taxes by investing into the traditional 401(k) if they are in the 25 percent income tax bracket.
  • Their nest egg will have grown to just over $350,000.
  • Social Security benefits, which Person A expects to grow at 2 percent, starts at $57,726.00
Unfortunately, there is bad news in the form of that mandatory health coverage cost through Medicare.

According to the Medicare Board of Trustees Medicare Part B is expected to inflate by over 5.1 percent while Part D is expected to inflate by 5.4 person for at least the next 8 years. This means those IRMAA surcharge charges will inflate at the same rate too.

Due to the required minimum distribution (RMD), coupled with their Social Security benefit, they will enter Medicare’s first IRMAA bracket at age 76 and remain there until age 81.

Their Medicare Part B and D premiums will be increased by about 40 percent which will automatically be deducted from their Social Security benefit.

Person A should expect to pay roughly $15,750.00 in extra Medicare premiums while also seeing their actual Social Security benefit being reduced by about 14.5 percent annually.

At age 82 Person A will then enter the second IRMAA surcharge bracket and their Medicare premiums will increase by about 100 percent. Person A will remain in this bracket until age 85.

The IRMAA surcharges in this period will total about $34,000.00 while their Social Security benefit will be lessened by as much as 23.8 percent.

The news gets worse by age 86 as Person A will enter the third IRMAA surcharge bracket where they will remain until age 89.

Their Medicare premiums will be increased by 160 percent, totaling $66,500.00 in excess surcharges and their Social Security benefit they receive will fall by 35.5 percent.

If Person A does make it to age 90 and above, they will be in the fourth IRMAA bracket where their Medicare Part B and Part D premiums will be increased by 220 percent.

Over the next 5 years Person A will be hit with over $170,000 in surcharges while seeing over 50 percent of their Social Security benefit being consumed by their Medicare premiums.

Person A, throughout retirement, if they live until age 84, will never see any added benefit from their investment in a traditional 401(k). All they will experience is ever increasing Medicare premiums and a dwindling Social Security benefit.

They are truly better off either smoking and dying earlier or an even easier solution; investing in the Roth 401(k) of their employer plan.

With a Roth they will never have to take distributions and if they do they will never count as income towards Medicare’s IRMAA. Yes, they will pay that extra $40,000 in taxes while working, but if they live until age 90 they will save over $142,000 in Medicare IRMAA surcharges. The other benefit, they will keep 25 percent more of their Social Security for themselves.

The choice is yours: Smoking or the Roth which is easier?


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