How to Calculate MAGI for IRMAA and Premium ACA Tax Credits
IRMAA MAGI calculation is vital but frequently glossed over. MAGI, however, is used twice by the IRS when trying to help you afford health care.
If you plan on retiring before Medicare, health care insurance is a considerable concern. Many folks will try to get Premium ACA Tax Credits to lower their health insurance bill. To get these credits, you need to understand MAGI.
Or, if you are on Medicare and want to avoid IRMAA, you need to understand MAGI!
Let’s learn how to calculate MAGI for IRMAA and ACA Credits!
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Cliff Penalty Warning!
Both of these, Premium ACA Tax Credits and IRMAA, are cliffs penalties.
One dollar over the cliff, and you have to pay IRMAA surcharges for an entire year. Similarly, misestimate your MAGI by one dollar with Premium ACA Tax Credits, and you owe the IRS all of the credits you received last year! This can easily double healthcare expenses.
Most articles skip over the step of actually calculating MAGI. MAGI calculation is essential! Especially when you talk about the difference a dollar can make with a cliff penality.
Understanding MAGI and the Cliff
With the ACA, the IRS pays Premium Tax Credits to your insurance company every month to lower the cost of your insurance.
You must estimate what your MAGI will be this year to get credits. Unfortunately, it is difficult to estimate your income, let alone understand adjustments and modifications that make MAGI for ACA tax credits so powerful.
For IRMAA, you use your MAGI from two years prior in order to calculate the amount of surcharge (read: tax on the rich) you pay. So, in a way, you are looking at fiddling with this years’ MAGI to affect IRMAA surcharges two years in the future for both you and your spouse.
MAGI is important, but it is calculated differently depending on the use. In fact, there are five different MAGIs depending on what you are trying to accomplish! For example, MAGI for IRA deductibility uses other modifications than MAGI for health care. MAGI for IRMAA and the ACA are slightly different as well! What a headache. Only the IRS could come up with such a scheme. And CPAs, well, they just plug the numbers into a program, and out comes the result. Sometimes they are less than helpful when you consider future tax planning by calculating this year’s MAGI before all the numbers are in.
A quick way to estimate your MAGI for IRMAA is to look at your Adjusted Gross Income from the prior year and then add back (or modify) it. We will learn what we have to add back below. Then, we can discuss some ways to control your income so that you don’t go over the cliff.
Let’s look closely at how AGI is calculated first. Drum roll please… Let’s start with the 1040.
IRS Form 1040
MAGI calculation starts with form 1040. Above is the top portion of form 1040 so we can calculate your Total Income and Adjusted Gross Income (AGI). But, first, let’s see what goes into this calculation.
Line 1 is all your gross income, minus the W-2 pre-tax deductions (401k, FSA, etc.).
2b includes all your taxable interest (such as savings and money market accounts). Notice that tax-exempt interest in line 2a is not included in your AGI. Don’t worry, though; for the ACA, it will be added back later when we modify your adjusted gross income and make AGI into MAGI.
Next, line 3b includes ordinary dividends. Qualified dividends are not explicitly included in the MAGI calculation. They are considered a part of your ordinary dividends and thus already included. Qualified dividends stack on top of your ordinary income when you pay Long Term Capital Gains Tax.
Lines 4b and 5b are complicated! They are the taxable amount of your IRAs, pensions, annuities, and social security. You only include the amount on which you pay taxes. For social security, this could be between 0-85%. Pensions are usually fully taxable! Taxation of annuities is complicated, but there is frequently an exclusion rate. On your tax-deferred accounts, include the entire amount of your IRA distribution. There are some exceptions (such as QCD or a QHFD). This section can get complicated! Have a look at last year’s 1040 to understand what is included in lines 4 and 5.
You add this all together PLUS line 6 add line 22 from schedule 1 to get your Total Income. So, we must review schedule 1 as well. So, let’s do that now.
Schedule 1 Additional Income
In line 6 of Form 1040, you add on any income on line 22 from schedule 1. It is best to look at lines 1-22 of schedule 1, as it pulls in many different income sources that will be included in your MAGI! This is your so-called total income.
I’m not going to go over schedule 1 in too much detail, but note it includes alimony received (from divorces before 2019), business income from Schedule C, and Capital Gains from schedule D. Also, add Schedule E, F, unemployment compensation, and “other” income.
As you can tell, schedule 1 is also very complicated and potentially pulls in 5 additional forms! You are best off to look at last year’s tax return and see what might apply to you this year.
We are ready to calculate your adjusted gross income.
Adjusted Gross Income
Back on form 1040, in line 6, we add the income from schedule 1 to get your total income.
After that, you go back to schedule 1 and subtract line 36 from schedule 1 to get your adjusted gross income.
These deductions (or adjustments) used to be called “above the line” deductions. This is because they were on the front page of the old 1040 and above the bottom line on that form: the adjusted gross income.
Also called “adjustments to your income,” you can look at schedule 1 again to see what they are. Unfortunately, there aren’t many above-the-line adjustments left! Most notably, IRA deductions and HSA contributions go above the line.
For the self-employed, ½ of self-employment tax, pre-tax contributions to retirement accounts, and health insurance premiums are deducted.
In addition, educator expenses and student loan interest (which phase out at $70k single or $140k filing jointly) and alimony (only if the divorce was before 2019) are occasionally deductible.
Back to form 1040, line 7, you subtract these adjustments from line 6 to get your Adjusted Gross Income.
Now Modify your Adjusted Gross Income to Calculate MAGI
Now that we have your adjusted gross income, we have to add back some items to call it modified. This is how you calculate MAGI! Add back (or modify) to your AGI.
You add back tax-exempt interest (usually from Municipal bonds).
The taxable portion of your social security is already in your AGI; what about the non-taxable portion of your social security?
For IRMAA purposes, you don’t include the non-taxable portion of social security for IRMAA.
Specifically for Premium ACA tax Credits, however, you add back the non-taxable portion of social security! This means you probably don’t want to claim social security between 62-65 if you get Premium ACA tax Credits.
Above, find the differences between IRMAA and ACA Premium Tax Credits.
Note that you add back tax-exempt interest and interest from US savings bonds for higher education to both.
In addition, foreign earned income is also added to both. Please note this is income from wages, not investment income. You can still deduct your Foreign Income Credit from your international investments.
The non-taxable portion of social security is added back for ACA Premium Tax Credits but not for IRMAA.
Modified Adjusted Gross Income for ACA Premium Tax Credits
Here are the additions.
Note that you add back the non-taxable social security benefits (line 51 minus line 5b). In addition, add back tax-exempt interest on line 2a. Finally, if you have any (non-investment) foreign earned income from form 2555, this is also added.
Now we know how to calculate MAGI, what can you do about it?
Strategies to keep MAGI Low
Remember, there are many ways to minimize your taxes in retirement.
Let’s talk about the ways you can keep your income low. We can do this line by line on the 1040
- 1 – Don’t make any income! This is important.
- 2a – Remember tax-exempt income is pulled back in, so interest paid by municipal bonds will count against you! Don’t own Municipal bonds.
- 2b – All your income from cash and bonds will be included.
- 3b – Ordinary dividends will be pulled in. If you buy and sell stocks, mutual funds, or ETFs frequently (or have actively managed funds), this can hurt!
- 4b – Pension income will fully count against you, as will ALL or part of social security. If you want ACA Premium Tax Credits, delay taking pensions and social security until age 65. In addition, pre-tax accounts (IRAs, 401k) should not be accessed for income. This includes Roth Conversions!
- Schedule 1 – Again, check out the sources of income you want to avoid on schedule 1. Note that you include capital gain harvesting here!
Summary of Strategies to Decrease MAGI
In summary, delay social security and pensions until you are 65. To avoid IRMAA, you may have to avoid these until later, especially if you plan to do partial Roth Conversions during your Tax Planning Window. Don’t forget that pensions are also fully taxable! Remember that income from municipal bonds is added back as well.
Minimize IRA and 401k distributions and Roth conversions.
In addition, become familiar with your sources of income on schedule 1 to see if they can be decreased. Finally, avoid harvesting capital gains (and take advantage of tax-loss harvesting).
What am I Supposed to Live On?
If you want help with your health care insurance costs, you have to decrease your income. The government does not care about your assets or net worth, only income.
How can you control your income regardless of your net worth?
Essentially, you have to live off cash and the basis of your brokerage account. Or tax-free income.
Sources of tax-free income include Roth accounts, Reverse Mortgages (if older than 62), cash value life insurance, and low-interest loans on your brokerage account.
What else can you do? First, contribute to an HSA or traditional IRA. If you have any self-employment (1099) income, use a SEP IRA or SOLO 401k to shelter the income from taxes and remove it from MAGI calculations.
Consider having international index funds in your brokerage account, as you can exclude the foreign income (on investments only)
Watch out for alimony from divorces before 2019.
What about my Standard or Itemized Deduction?
Pay special attention: The Standard Deduction is not used in the calculation of MAGI! You don’t get the $12,200 (single) or $24,400 (Joint) deduction as this is a below-the-line deduction.
Nor do you get to use itemized deductions! This means charitable donations don’t count!
State and Local Tax (SALT) deductions, mortgage interest, medical deductions, and child care costs/deductions also do not count for MAGI calculation.
Video: MAGI for IRMAA
Summary: MAGI for IRMAA Calculation
That’s how you calculate your MAGI for IRMAA!
If you don’t want to do all the work above, see IRS publication: How to Estimate your Expected Income.
On the other hand, knowing your income sources allows you to understand better how to lower them.
As healthcare insurance is one of the most significant expenses, calculating MAGI to claim ACA Premium Tax Credits and avoid IRMAA is essential.
Here, we take a deep dive into the MAGI calculation to show what counts and what doesn’t count as income. Control your income and control your health care expenses.
Another great article on MAGI and the ACA implications.