Correcting the “Sting” of Failing to Factor in the Medicare Component on a Large 401K Distribution
Single tax filer, 70 year old retiree (Social Security deferred and in process of filing) is seeking input on how to mitigate the sting of having completed a $213,824.50 gross distribution from a 401k plan without factoring in the negative impact on Medicare!! The transaction was done on 9/3/2021.
While watching a recent seminar on retirement and taxes, my oversight and its ramifications suddenly hit me: Come 2023, IRMAA and big jumps in Medicare Part B and D Premiums. (Regarding Part D, supposedly the increase is even applicable to Medicare Advantage Plans, which has Part D embedded, and no separate premium. Plus my MAP is a $0 premium plan. So, I don’t see how Part D IRMMA will come into play here.)
Total Gross 401K Distribution, $213,824.50, made 9/3/21, includes tax withholdings, 20% for Federal and 10% withholdings for State (not required) but wanted to avoid being penalized for under withholding and having to pay estimated taxes going forward.
Rationale for my withdrawal was to take advantage of the high stock market and create a bucket of funds ($150,000) that would not be at market risk and use the proceeds for discretionary living expenses (3 years): a) increase quality of life; b) emergency funds; and post-covid pent up travel desires.
Upon realizing that I failed to factor in the Medicare component of my withdrawal decision, I tried to return some of the money back to my 401K but the Custodian advised that once distributed, it was not possible to return all or any of the amount distributed. Instead I was told that I could do a 60 day indirect rollover with the portion of the funds I desired to return to a tax deferred qualified account and a Form 5498 would be generated.
Thinking that I had to open a new account that bore the title, e.g., “Jane Doe IRA Rollover”, I contacted my brokerage where I have a traditional IRA and was advised that I did not need to open a new account with the above title, I could just deposit a check for the desired amount into my existing IRA Deposit Sweep position and that would satisfy the 60 day Rollover requirement. And later if I wanted to transfer the funds to another institution, e.g., I could just do a direct transfer to the other institution but not a rollover (permitted only once every 12 months).
The distribution of 9/3/21 was the first time I ever took money out in this large of an amount from retirement assets. Prior years distributions from qualified plans (IRA or 401K) were to meet ordinary / essential living expenses only, while always managing to stay in a low marginal tax rate / bracket (12% or less).
As such, I need to correct or minimize the sting of my recent 401K distribution / withdrawal mistake on or before 11/2/2021. Also, I want to ensure that information that has been given to me is correct and/or my understanding of information read on 60 day indirect rollover is also correct. Plus, I want to explore another idea that has cropped up in my head and determine if it’s feasible and worthy of consideration.
To this end, your feedback / insight / response to the following questions would be greatly appreciated:
1) Can I deposit the funds received from my 401K distribution (now in my savings account) to an existing IRA although the account title does not say rollover and simply account for the IRA Contribution on Form 1040 line 5a and 5b with a rollover notation, which will be followed later by Form 5498?
2) To avoid a big jump in my Medicare Premiums and IRMAA in 2023 do I have to deposit the full $213.8K in an IRA / rollover? Or can I do a partial deposit, $100K of the $150K (net received from the 401K plan distribution) and reduce the impact of the full gross distribution ($213.8K), which will be reflected on the 1099 R? Will a partial deposit suffice to get my MAGI below the higher income threshold or several tiers down to reduce the impact of Medicare / IRMAA on Part B and D? For tax year 2021, my only other reportable income is less than $1K (dividends).
3) Assuming that Q # 1 is correct & depending on answers to Q # 2 , I’m also considering depositing the full $150K (now in my personal savings account) to my IRA Deposit Sweep position and withdrawing from it selectively in future years, and staying below the high income threshold tier that would impact Medicare. With the money in the IRA Deposit Sweep, it’s easily accessible, free of market risk and becomes a “pseudo checking account”. Also, I have to determine if there are any restrictions on keeping cash in the IRA Deposit Sweep and for how long. In my 401K Plan, there is no vehicle to park cash; all money has to be invested in one of the funds.
4) Is there an opportunity for an IRA Roth here? Can it be used to correct or reduce the sting of being in a high income threshold for Medicare, e.g., moving down to a lower tier, if not below the lowest tier? To this end, I would consider doing a $100K IRA Roth before year end. If so, this would leave $50K in my Brokerage IRA Deposit Sweep to use as needed in conjunction with Social Security future monthly payments, which will cover a large percent of my essential living expenses, if not all. Once Social Security kicks in before year end and RMD starts at age 72, my control over reportable income for tax purposes decreases. My total assets in qualified tax deferred plans are somewhere in the range of $1.5M – $2.0M.
Thanks in advance for your thoughts and consideration.
Permalink Submitted by Alan - IRA critic on Fri, 2021-10-15 01:24
Yes. You do not have to open a new rollover IRA account, but if you are in a state like CA with poor IRA creditor protection, you might want to do so to improve your creditor protection.
You can do a full or partial rollover based on what IRMAA tier you are willing to accept or avoid. These tiers are adjusted for annual inflation. For example, it is expected that the 2022 first tier will start at 182k, an increase of 6k if MFJ. You can control your MAGI based on how much you roll over to an IRA, but you will not know the exact tiers for 2023 until Nov, 2022.
There is usually no limit to the amount you can invest in your IRA sweep account, usually a MM fund. Of course, right now these accounts are earning next to nothing.
Any Roth conversion will increase your IRMAA MAGI in the conversion year, but provide you with a source to take Roth withdrawals in future years that are tax free, producing a lower IRMAA MAGI in those years. Therefore, you increase MAGI up front, but lower it in future years, a trade off.
In analyzing IRMAA’s effect, you might assess it as an additional income tax. Of course, income taxes apply to every additional dollar of taxable income, but IRMAA surcharges do not change until you penetrate the next tier. So once you pass into a new tier, you might want to increase MAGI to the top of that tier, but not beyond the top.
Permalink Submitted by Claude H. Collins on Wed, 2021-10-20 05:56
Alan, thank you so very much for responding to my specific questions and for sharing your insight, plus clarifying the point that a Roth conversion would not resolve my problem but enhance it relevant to Medicare, if done in 2021. You gave me a lot of comfort about my options. Plus, I contacted my IRA Brokerage firm and confirmed that there were no restrictions on parking cash in the IRA Cash Sweep Reserve holding position. I also learned that funds can remain in that account until one’s 99th Birthday! And, as to interest rate on the balance, as you stated, it’s next to nothing! So, I’m pleased to advise that on Monday (10/18), two weeks before the deadline (11/2), I wired (did not want to leave anything to chance) the $150K from my personal saving into my brokerage IRA as an Indirect Rollover and as of Tuesday, all seems in place on both ends. Come January 2022, with Social Security in the mix, I’ll make a better decision on where my MAGI best meet my essential and discretionary expenditures for the new tax year without raising the tentacles of Medicare / IRMAA to the extremes and un-necessarily, to boot! Regarding the tax withholdings on my 401K distribution, I guess it’s my “opportunity cost” for failing to factor Medicare into my initial decision. Indeed, an incentive to file income taxes as soon as that 1099 R hits my mailbox, although I understand that the Form 5498 (an information sheet and not filed with tax returns) will not be generated until around June. Looks as though documentation and saving all paper trail on the funds movement will be the order of business in dealing with any red flags that might pop up in the interim. Again, thank you for reading my inquiry and for your timely response, and for your participation in the IRA Discussion Forum. Not only is it a great service to the community but very educational. Thanks to all that makes it possible!