What happens to Medicare premiums after I get a gift?

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Q. I am to receive a small monetary gift with an option for a lump sum distribution or installments over five years. I am still working although I am retirement age. I’m not collecting a pension and only registered for Part A of Medicare. I will probably retire in 2021. How would the lump sum affect Part B premiums? How will the gift be taxed?
— Planning

A. Let’s start with how Medicare premiums are calculated.

They are based on modified adjusted gross income (MAGI), which in most cases is your adjusted gross income plus any tax-exempt interest or dividends, said Laurie Wolfe, a certified financial planner and certified public accountant with Lassus Wherley, a subsidiary of Peapack-Gladstone Bank, in New Providence.

She said the government uses your tax return from two years prior to determine your MAGI, so the 2020 surcharge would be based on your 2018 MAGI.

“In 2020, surcharges for a single person begin when your MAGI exceeds $87,000 — $174,000 if married,” Wolfe said. “Much like our tax brackets, the surcharges have brackets whereby the more you make, the higher your surcharge. The Medicare Part B surcharges range from $57.80 to $347 per month per person.”

Wolfe said there are a few key things to consider when choosing your option.

First, does the additional income you have to report result in your MAGI being an amount that either subjects you to the surcharge, or if you are already subjected to it, results in an even higher surcharge?

Second, consider your tax bracket, Wolfe said.

Will this additional income, if all is taken in one year, put you in a higher tax bracket? Will it subject you to the Net Investment Tax — 3.8% tax on investment income if your gross income exceeds $200,000 for singles, $250,000 if married?

This is what is nice about the 5-year option, Wolfe said.

“In most cases you can decide how much to take in each of those five years as long as it is all taken by the end of those five years. This gives you better control of your MAGI,” she said.

On the other hand, if the five-year option also puts you in a position where you incur the surcharge, you may want to take it all in one year so the surcharge only affects one year, she said.

“What this all boils down to is that you need to look at a five-year projection of your income and then determine which is the optimal decision when comparing the total tax cost of the additional income and the additional Medicare surcharge incurred in each option,” she said.

Now to your second question: How is this taxed?

It depends because you didn’t say exactly what you will be receiving, Wolfe said.

The way you described the payouts make it sound like it’s from an annuity.

It could be a qualified retirement account or a non-qualified account.

A qualified annuity is an annuity that’s purchased with pre-tax money through a tax-deferred account such as a 401(K) or an IRA. If it is this type of account, Wolfe presumes you inherited this account rather than receiving it as a gift.

If the annuity is in an IRA account, you could take advantage of the Qualified Charitable Distribution (QCD) rules if you have reached age of 70 ½, she said. These rules allow the owner of an IRA, or an inherited IRA, to make charitable contributions from the IRA.

Although the contributions are still considered withdrawals from the account, they are not taxed, she said.

“This has the dual effect of not only lowering your tax on the distribution but also lowering your MAGI for the Medicare surcharge purpose,” she said. “So, if you are charitably inclined, this would be a huge benefit. Instead of making charitable contributions from your checkbook and only benefiting if you itemize your deductions, you would directly lower your MAGI and your total tax.”

If, on the other hand, you receive a nonqualified annuity, then the original owner of the annuity would have paid for the annuity with post-tax dollars.

Wolfe said this amount would not be taxed again upon distribution, but rather, you would be taxed only on the earnings within the account when you take money out.

“For example, if the original owner paid $30,000 for an annuity that is now worth $50,000, you would only pay tax on the $20,000 earned within that account, or 40% of each withdrawal,” she said. “This type of account would not qualify for the QCD rules.”

There are some other possibilities that require advanced tax planning, Wolfe said.

For example, you could possibly qualify to exchange the annuity you inherit for another annuity, she said. This is called a Section 1035 exchange. A qualified annuity can only be exchanged for another qualified annuity and a non-qualified for another non-qualified. For this, you should speak to an experienced advisor.

Lastly, if this is not an annuity and simply a gift of money, then there would be no tax on the amount, Wolfe said.

“For example, if I decide to gift my niece $50,000 and give her a choice of all now or spread over five years there is no taxable event for her,” Wolfe said. “Gifts are not taxable to the recipient.”

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This story was originally published on August 21, 2020.

NJMoneyHelp.com presents certain general financial planning principles and advice, but should never be viewed as a substitute for obtaining advice from a personal professional advisor who understands your unique individual circumstances.