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Financial Planning

High-Income Individuals Face New Medicare-Related Taxes

 

According to a study conducted by the Employee Benefit Research Institute (EBRI) in 2020, healthcare expenses for retirees continue to increase, with the average 65-year-old couple needing an estimated $300,000 in savings to cover their healthcare expenses in retirement. This highlights the importance for retirees and those approaching retirement to be aware of the additional Medicare-related taxes outlined in the 2010 healthcare reform law. By understanding how these taxes may impact their retirement savings and income, individuals can better plan and prepare for their healthcare expenses in retirement. (Source: "2019 Retiree Health Care Cost Estimate" EBRI Issue Brief, February 2020)

The 2010 health-care reform law included new Medicare-related taxes that first went into effect in 2013. These levies target individuals and families with a high income. Here are some essentials:

Additional Medicare Payroll Tax

If you receive a paycheck from Fortune 500, you're likely familiar with the Federal Insurance Contributions Act (FICA) employment tax; if nothing else, you've undoubtedly seen the tax deducted from your Fortune 500 paycheck. The old age, survivors, and disability insurance ("OASDI") element of this FICA tax is 6,2% of covered wages (up to $147,000 in 2022) (1). The hospital insurance or HI portion of the tax (commonly referred to as the Medicare payroll tax) is generally 1.45% of covered wages and has no wage limit. FICA tax is imposed on both employers and employees (an employer is subject to the 6.2 percent OASDI tax and the 1.45 percent HI tax on wages, and each employee is subject to the 6.2 percent OASDI tax and the 1.45 percent HI tax on wages), with employers responsible for collecting and remitting the employees' portions of the tax.

Self-employed individuals are responsible for paying an amount equal to the combined employer and employee rates on net self-employment income (12.4 percent OASDI tax on net self-employment income up to the taxable wage base and 2.9 percent HI tax on all net self-employment income), but they can deduct the employer portion of self-employment taxes paid.

If you are married and file a joint federal income tax return in 2022, the additional HI tax applies to the extent that your and your spouse's combined wages exceed $250,000. The additional tax applies if your wages exceed $125,000 (2) and you are married but file a separate return. The wage threshold for the remainder of the population is $200,000. Therefore, a single individual with annual wages of $230,000 will incur HI tax at a rate of 1.45% on the first $200,000 of wages and at a rate of 2.350% on the remaining $30,000 of wages (3).

Employers are responsible for collecting and remitting the additional tax on compensation exceeding $200,000. (Employers do not account for the spouse's income of married employees.) You are responsible for the additional tax if the quantity withheld from your wages is insufficient (you are entitled to a credit on your federal income tax return if too much is withheld). The employer's portion of the HI tax remains unchanged at 1.45%.

If you are self-employed, the additional 0.9% tax applies to self-employment income in excess of the above thresholds (reduced by wages subject to FICA tax). You cannot deduct any portion of the additional tax if you are self-employed.

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Medicare Contribution Tax on Unearned Income

In 2013, a 3.8% Medicare contribution tax also went into effect for the first time. Referred to as the "unearned income Medicare contribution tax" or the "net investment income tax," it is imposed on the unearned income of high-income individuals (the new tax is also imposed on estates and trusts, although the rules are slightly different). The tax is equal to 3.8% of the lesser of your net investment income (generally, net income from interest, dividends, annuities, royalties and rents, and capital gains, as well as income from a business that is considered a passive activity or a business that trades financial instruments or commodities) or your modified adjusted gross income (basically, your adjusted gross income increased by any foreign earned income exclusion) that exceeds $200,000 ($250,000 if you are married and filing separately).

Therefore, you are only subject to the additional 3.8% tax if your adjusted total income exceeds the above-listed dollar thresholds. Note that for purposes of the additional tax, interest on tax-exempt bonds, veterans' benefits, and excluded gain from the sale of a primary residence are not considered net investment income.

Distributions from qualified retirement plans and IRAs are also not deemed investment income.

Both Taxes Can Apply

Both taxes may apply, but not to the same income. In other words, if your earnings surpass the dollar threshold applicable to your filing status, you must pay the new Medicare payroll tax. If you also have unearned income, that unearned income may be subject to the new Medicare tax on unearned income (assuming your modified adjusted gross income exceeds the threshold).

  • "What is the Old-Age, Survivors, and Disability Insurance (OASDI) Program?" (Robinhood 2022)
  • "What Is Form 8959: Additional Medicare Tax" (Turbotax 2022).
  • "High-Income Individuals Face New Medicare-Related Taxes" (Walker Covey, 2022).

Conclusion

Retirement planning can be compared to preparing for a long, fulfilling journey. Just as a traveler needs to pack the right essentials and plan for different scenarios on their trip, retirees need to carefully plan their financial future to ensure they have enough resources to last throughout their retirement years. Similar to a traveler who may encounter unexpected detours or delays, retirees may face unforeseen expenses or changes in their financial situation. Therefore, it's important to have a well-thought-out plan that includes contingencies and allows for flexibility. By being proactive and taking the necessary steps to plan for retirement, individuals can help ensure a smooth and enjoyable journey into their golden years.

This material was prepared by Broadridge Investor Communication Solutions, Inc., and does not necessarily represent the views of  The Retirement Group or FSC Financial Corp. This information should not be construed as investment advice. Neither the named Representatives nor Broker/Dealer gives tax or legal advice. All information is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy. The publisher is not engaged in rendering legal, accounting or other professional services. If other expert assistance is needed, the reader is advised to engage the services of a competent professional. Please consult your Financial Advisor for further information or call 800-900-5867.

The Retirement Group is not affiliated with nor endorsed by fidelity.com, netbenefits.fidelity.com, hewitt.com, resources.hewitt.com, access.att.com, ING Retirement, AT&T, Qwest, Chevron, Hughes, Northrop Grumman, Raytheon, ExxonMobil, Glaxosmithkline, Merck, Pfizer, Verizon, Bank of America, Alcatel-Lucent or by your employer. We are an independent financial advisory group that specializes in transition planning and lump sum distribution. Please call our office at 800-900-5867 if you have additional questions or need help in the retirement planning process.

The Retirement Group is a Registered Investment Advisor not affiliated with FSC Securities and may be reached at www.theretirementgroup.com.


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