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March 31, 2013
Your MAGI, IRMAA and Means Testing
My initial contact with the American Red Cross occurred in 1960 when I delivered a local newspaper to one of their neighborhood centers. It was then that I learned of their periodic blood donation drives and the "Blood Bank." I was too young to donate at the time but the idea of being able to make "deposits" so that I or my future family could have access to blood needed during an operation, appealed to me. Consequently, I became an active participant in corporate blood drives throughout my career. Unfortunately after I accumulated a "Blood Bank" balance of several gallons, the Red Cross and hospitals changed the rules which then wiped out my "Blood Bank" balance.
I am reminded of that anecdote as I wonder about the ability of the U.S. government to change the rules affecting Medicare and Social Security. Now that I am a Medicare participant and a Social Security recipient I am familiar with the various acronyms used to describe how payments and benefits are calculated. Just about everyone understands that Medicare premiums are deducted from one's Social Security distribution. Not everyone is familiar with how those amounts, both the deduction and the distribution, are calculated. As with many government programs, some parts are straightforward and other parts are very complicated.
MAGI is a Medicare acronym for "Modified Adjusted Gross Income" and it is calculated by adding tax exempt income to one's Adjusted Gross Income as reported on his or her Federal Tax return. The definition is straightforward even though increasing the Medicare premium as a result of adding tax exempt income makes that income seem not-so-tax-exempt. The higher the income, the higher the premium, which is what "means testing" looks like.
IRMAA is another Medicare acronym for "Income Related Monthly Adjustment Amount" and applies to Part B (Hospitalization) and Part D (Prescription Drug) coverage under Medicare. It is a matching process by which MAGI derived income is assigned to one of four ascending levels. As a result, higher premium deductions are taken from Social Security distributions at each new level. This is another example of "means testing."
The process of calculating Social Security benefits is much more opaque. It is based on the highest 35 years of contributions and is then reduced to a monthly average figure. Next, the year one turns 62 becomes the basis for determining "bend points" in calculating benefits. For someone who turns 62 in 2013 the first "bend point" is at $791 per month and the second at $4,768 per month. Social Security benefits are designed to cover 90% of one's average monthly income (subject to FICA) up to the first "bend point", 32% of the amount between $791 and $4,768 per month, and 15% of the amount over $4,768 per month. When displayed graphically, the benefit amount "bends" to the right as a smaller portion of one's average monthly income is calculated.
The formula for the ratio that determines the "bend point" amounts can be followed mathematically, but the system of basing future benefits on historic average wage levels is extremely complex. Social Security benefits are supposed to be based on one's contributions over one's working career, in other words, an individualized record. The system that computes the benefit seems to be "one size fits all" based on one's birth year rather than on the pattern and amounts of one's contributions.
From an investment perspective, the return on one's contributions to Social Security under the current system, produces a zero rate of return for high earners/high contributors. Further "means testing" will actually make those investment returns negative.
Politicians from both parties talk endlessly about "bending the cost curve" in health care and "means testing" entitlement payments like Social Security. From an individual's viewpoint, the system already uses "means testing" to bend premium costs upward while "bending the payment curve" downward in terms of covering Social Security participants' average income.
While I question the logic of the current method for "means testing," I have deeper concerns about the future. If the Red Cross can change the rules regarding their "Blood Bank" and the government of Cyprus can confiscate a portion of an individual's bank account, it is indeed worrisome to think what our government can do to our current "entitlements."
Raymond A. Beplat, CFA
Chief Investment Officer