Planning around Medicare ‘surtax’
by William G. Lako Jr.
Business Columnist
December 28, 2012 12:00 AM | 2561 views | 0 0 comments | 30 30 recommendations | email to a friend | print
William G. Lako Jr.<br>Business Columnist
William G. Lako Jr.
Business Columnist
With many other tax rates likely increasing, many investors are particularly unhappy about the Medicare “surtax” on net investment income. Simply “quit investing” is hardly an option for most of us who are saving for our retirement. So the next question is, “How can I minimize the Medicare surtax for my situation?”

First, and foremost, you should understand that not every strategy will work for every investor, as every family’s financial situation is different. You should seek the help of a financial adviser or an accountant who can look at all the variables of your unique situation.

With 2013 upon us, there are two basic strategies: reduce your modified adjusted gross income or reduce net investment income. As we have discussed, for the purposes of the Medicare surtax, MAGI is calculated as your adjusted gross income plus your net foreign income exclusion. The best way to lower your MAGI is to lower your income. No, you do not have to ask for a pay cut. However, you do want to reduce your taxable pay by contributing money to your 401(k) or retirement plan at work. Contributions are taken pre-tax. By maximizing your contributions, you should able to reduce your wages reported on your W2.

You should also consider the other elements in your employee benefit package, such as a health care and dependent care flexible spending account. In 2013, you should be able to defer $2,500 of your pretax income to an FSA for health care costs. While annual maximum limit has been cut in half for health care as a result of the Patient Protection and Affordable Care Act, you should still be able to contribute up $5,000 for qualifying dependent care, again, lowering the wages reported on your W2.

If you are not covered by an employer-sponsored retirement plan, you may be able to make deductible IRA contributions that should lower your MAGI. However, to determine if you are eligible for a deductible IRA contribution, you’ll need to recalculate your MAGI, recapturing some income that was not added when calculating your MAGI for the Medicare surtax. I warned you this was fun stuff.

When it comes to lowering your net investment income, you should proceed with caution. While tax implications need to be considered, taxes should not always be the deciding factor. The goal is to grow your money. Unfortunately, making more money will generate more taxes.

If you do not rely on dividends for income, you may consider investing in growth stocks, so you should only pay taxes if you recognize capital gains when you sell. If you are in a position where you rely on dividends to supplement your income, you may consider investments in general obligation bonds of state and local governments, which are generally free of federal income tax. You may also choose to allocate your dividend paying stocks into retirement accounts where your assets grow tax-free until they are withdrawn.

You cannot avoid taxes altogether, but you can certainly do your best to minimize their impact on your financial future. Overall, your best strategy is one that will consider all the variables that are unique to your financial situation.

William G. Lako Jr., CFP, is an executive in residence at Kennesaw State University’s Coles College of Business and a principal at Henssler Financial. Lako is a certified financial planner.The MDJ will periodically publish columns from KSU business faculty.

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