Roth conversions can be a great way to create tax-free income in retirement. However, if you've signed up for Medicare or plan to within a couple of years, take notice: Your Roth conversion could increase your Part B and D premiums—sometimes significantly. Read this article to understand why.

Why Complete a Roth Conversion?

With a Roth conversion, you convert a traditional IRA into a Roth IRA to enjoy tax-free distributions in retirement. What's more, you do not have to take required minimum distributions (RMDs) with Roth accounts. These advantages can increase retirees' tax flexibility in retirement.

Many people use down markets like we have experienced this year to leverage conversions. That's because you pay income taxes at the time of your conversion. So, if your portfolio value has dropped, the taxes you pay drop too.

But Roth conversions come with a couple of caveats. First, you should avoid making withdrawals for five years or face a 10% penalty. You also want to have the cash to pay the income taxes you owe. That way, you avoid using other retirement accounts to cover your tax payment, potentially incurring more taxes and penalties.

Finally, conversions could increase your Social Security taxes and certain Medicare premiums. (Read more about Social Security taxes in the Money article "This Roth IRA Move Can Create a Massive Tax Headache.”)

How Roth Conversions Affect Medicare Premiums

Many people have made Roth conversions and been shocked by an increase in their Medicare premiums a couple of years later. This is because of a little-known charge called the income-related monthly adjustment amount, or IRMAA.

IRMAA essentially means people with higher incomes pay higher premiums for Medicare Parts B and D. It works like this:

• Medicare Parts B and D have a regular premium that everyone pays.

• Medicare adjusts the premium upward based on the modified adjusted gross income (MAGI) on your tax returns two years prior.

• So if your Roth conversion bumps your MAGI above a certain amount (currently $91,000 for individuals and $182,000 for married couples filing jointly), you can expect an increase in your Medicare premiums two years out.

• Medicare will generally remove IRMAA within a year or two—unless you do more Roth conversions or something else to raise your MAGI.

The premium increase can be substantial too. For example, your monthly Part B premium in 2022 is $170.10. But IRMAA can increase that premium up to $578.30—per month!

If you opt for Part D drug coverage, you pay a monthly premium as detailed in the plan you select. However, Medicare can tack on an IRMAA increase so that you're paying the plan premium plus up to $77.90 per month.

What Should You Do?

Roth conversions aren't as cut-and-dried as they often appear, especially if you receive Medicare. However, you may have strategies to help reduce your MAGI, such as spreading out conversions, making charitable contributions, or completing tax loss harvesting.

Consider talking with a financial advisor or tax professional before you do any Roth conversions. That way, you can decide the timing and amount based on your overall financial picture and goals.

Schedule a complimentary consultation with one of our fee-only financial planners to discuss your personal situation.

This material was prepared by Kaleido Inc. from information derived from sources believed to be accurate. This information should not be construed as investment, tax or legal advice.