WEALTH TIP OF THE MONTH

Reducing Taxes Through the
Use of a Roth Conversion

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One way to lower your taxes in retirement is by avoiding higher tax brackets, increased Social Security taxes and Medicare premiums. The use of Roth conversions to reduced Required Minimum Distributions (RMD), will help in reducing Social Security taxes and Medicare premiums, by lowering your tax bracket.
 

There are two things to watch out for when taking retirement distributions. They are higher marginal tax rates and a spike in income related Medicare premiums. Utilizing Roth conversions while both partners are alive may help reduce these tax and premium hikes.

In addition to your Part B or Part D premium, if your income is above a certain level, you may have to pay Medicare’s income related monthly adjustment amount. There are four income brackets that the Social Security Administration sets for single filers as well as married couples.

Most people are not aware that the first year after a death of a spouse, the widow will face higher tax brackets as a single filer than they did when filing as a couple. Not only will the widow be in a higher tax bracket, but the widow may also pay larger Medicare premiums three calendar years later.

For example, if a spouse died in 2018, the widow in 2019 would be forced into the single tax payor bracket if not remarried. The widow’s standard deduction would be lower, and more to the point, if the late spouse and widow were the same age of at least 65, the spouse’s adjusted gross income would likely be only slightly lower than it was before the spouse died due to the fact that the surviving spouse will now collect only the higher of the two Social Security Benefit amounts.

As an example, while both partners were alive, and using a modified Adjusted Gross Income (AGI) of $181,000. Their 2022 taxable income would be $150,000 - $300,000. This is derived by taking the $181,000 of AGI and subtracting the standard deduction of $28,700, leaving their federal income tax to be $24,740. When the husband is widowed, his AGI and modified AGI would be $171,000 because he has lost the smaller of the Social Security Benefits from his wife. So, after deducting the standard deduction of $14,700 for a single filer, his 2022 taxable income would be $156,300 and his federal income taxes would be $31,347. A $6,607 increase in federal income tax as a single filer over what they paid when they were filing jointly. If you then add state income taxes, the result will be even worse.

With regard to the Medicare premiums, assuming the same modified AGI from above and both spouses still living, they each would pay $170.10 per month in Medicare Part B premiums in 2022 for total annual premiums of $4,082.40 derived at by taking the monthly premium of $170.10 and multiplying by 24 months. Unfortunately, for a widow, 2022 monthly Medicare premiums would be $544.30 which is comprised of the $170.10 standard premium plus an additional $374.20 of income related monthly adjustment amount dictated by Medicare thus creating a total annual premium of $6,531.60. This is a 60% increase of $2,449.20 more in premiums than the joint Medicare premiums would have been when both were still alive.
 

One of the methods of combating this would be by taking partial Roth conversions while both partners are alive. The couple may have to pay an additional 22% on the Roth converted income however, in the long run this strategy may prove to be much better than having the widow pay federal income taxes of 24% on the withdrawal later on in life.

So, consider Roth conversions as a method of reducing both joint lifetime Medicare premiums and surviving spouses Medicare premiums three years after becoming a widow, all the while reducing income taxes.

If you wish to learn more, please contact me at 818-342-9950.

Barry serves on the exclusive SCOPE™ faculty in California helping to educate successful people. 

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