We got to visit the Aalsmere flower auction facility near Amsterdam a few years ago. They have a cafeteria for visitors and workers, welcomed by what I call scary Chef!
The Gift of the Magi
The original Gift of the Magi is an O. Henry story about a young couple sacrificing their individual prized possessions to give the other a special Christmas gift. For Social Security and Medicare, MAGI is a whole different ballgame that gives you the potential opportunity to plan (a gift to yourself!) to avoid sacrificing (money.)
This blog post will be a little technical, but could contribute to tax savings when you plan for MAGI. I will try to keep it as entertaining as possible given the subject matter.
What is MAGI
MAGI is Modified Adjusted Gross Income and is calculated by taking your Adjusted Gross Income (AGI) and adding in tax-free income, like interest on state and municipal bonds. There are some other, less common items, that get added back also, for example savings bond interest excluded from income because it was used for post-secondary education; check with your tax advisor.
Why is MAGI important?
For pre-retirees, a higher MAGI may restrict your ability to contribute to a traditional pre-tax or a Roth IRA.
For retired people, a higher MAGI may subject some of your social security income to taxation and may cause you to pay higher Medicare Part B premiums. The Medicare higher premium, the Income Related Monthly Adjustment Amount, is called IRMAA (I pronounce it like the name, Irma.) The wind is called Mariah. (The Mariah link is fun, really.)
But I’m not rich!
Most of us aren’t rich, but MAGI can still affect us. A MAGI as low as $25,001 for a single person (or $32001 for a married couple) will start to subject Social Security payments to income taxes.
How can I plan around MAGI?
First the disclaimers – If you’re a wage earner, like me, your planning possibilities are limited. Small business owners have more control over wage versus business income and can exercise some control over timing of income. I have to warn you again to discuss planning with your qualified tax advisor; we are discussing generally available information here that will not directly apply to your personal tax situation.
For pre-retirees, you may be able to use a technique called the ‘backdoor Roth’ to fund a Roth IRA, regardless of MAGI. A good article from Ed Slott, an IRA expert, on backdoor Roth IRAs is here.
For both pre-retirees and retirees, the ways to lower MAGI are fairly straightforward:
-lower your W-2 and/or 1099-R income
-lower your tax-exempt income.
One way for retirees to lower 1099-R income is to take out less from the retirement accounts you have control over (IRA, SEP, 401(k), 403(b), etc.), subject of course to the Required Minimum Distribution (RMD) for those 70 ½ and over. If you have a Roth IRA, withdrawals from the Roth won’t count towards MAGI.
Zero coupon municipal bonds exist that would pay out no tax-exempt interest until maturity. Your financial advisor could help you plan the use of municipal zeros, instead of municipals paying semi-annual interest, to support MAGI planning.
If you have bank accounts, you could use withdrawals from savings accounts or CD’s as a substitute for the 1099-R income that you are avoiding.
Finally, selling mutual funds or stocks that have capital gains will contribute to AGI and MAGI only to the extent that you have a gain when you sell.
MAGI – gift or not?
I guess there are similarities to the Gift of the Magi because MAGI planning and executing requires you to give up something special, your time and perhaps payments to a tax advisor. The gift you get back (a gift to yourself and loved ones) is the tax and Medicare Part B premium savings from your efforts that could be significant.
When I was a child I lived in France for a while courtesy of the USAF. Citroen cars were popular and this model of a DS in the window of a toy car shop in Haarlem, NL brought back memories.
Actions you can take include:
-Consider how MAGI can affect your tax situation pre- and post-retirement.
And if you have not seen the “Why you should read this blog…WIIFY” post, it’s here.
Back in the post Why not make money on your groceries? I thought a quote was from the movie ‘An Officer and a Gentleman’. A reader informed me it was from ‘A Few Good Men’. Thank you for the correction!
Questions, comments, or suggestions for retirement surprise areas you want to know more about?
-Leave a comment
-Use ‘Contact’, above, to send an email.