For most retirees, healthcare represents the largest and least predictable expense in retirement, potentially reaching hundreds of thousands of dollars over time. While healthcare costs can arise from many sources, Medicare stands out as a central element of the financial planning process. Despite its significance, however, the rules governing Medicare remain a source of confusion for many Americans.

Gaining a clear understanding of how Medicare functions, the decisions it requires, and how those decisions interact with a broader financial plan is critical for retirees and those nearing retirement. Making well-informed choices can help preserve savings, optimize health coverage, and support consistent cash flow throughout a multi-decade retirement.

The growing relevance of Medicare

Medicare was enacted into law by President Lyndon B. Johnson on July 30, 1965. It was originally composed of Part A (Hospital Insurance) and Part B (Medical Insurance), collectively referred to as Original Medicare. Over the years, Congress has broadened the program to include more beneficiaries and additional benefits, such as prescription drug coverage. Today, Medicare serves over 68 million Americans, including approximately 61 million individuals aged 65 and older and 7 million younger people with disabilities.¹

The importance of Medicare has grown alongside steadily rising healthcare costs. According to the Centers for Medicare and Medicaid Services, national health expenditures in 2024 reached approximately $15,474 per person, representing 18% of GDP. Over the coming decade, healthcare spending is projected to grow at a pace that outstrips GDP growth. For retirees who often rely on fixed incomes, Medicare provides critical financial relief against these escalating costs.

The program is currently organized into four parts:

• Part A covers inpatient hospital stays, skilled nursing, and hospice care, and is typically available at no premium for those with at least ten years of work history.
• Part B covers physicians’ services, outpatient care, and preventive services, and requires a monthly premium that may be subject to income-based surcharges.
• Part C, known as Medicare Advantage, is administered by private insurers as an alternative to Original Medicare and often includes expanded benefits such as dental, vision, and hearing coverage.
• Part D offers optional prescription drug coverage through private insurers and is also subject to income-based surcharges.

A widely held misconception is that Medicare is entirely free, given that individuals have contributed to it through payroll deductions over many years. While Part A premiums are indeed waived for most enrollees, Part B premiums, supplemental coverage, and out-of-pocket costs can accumulate considerably. This is precisely why incorporating Medicare decisions into a comprehensive financial plan is so essential.

The Medicare income cliff: Why IRMAA planning matters

One of the most significant Medicare surprises retirees encounter is IRMAA—an additional charge applied to Medicare premiums when income exceeds $109,000 for an individual or $218,000 for a married couple filing jointly. These thresholds apply to coverage year 2026 and are adjusted on an annual basis.

IRMAA, which stands for Income-Related Monthly Adjustment Amount, affects both Medicare Part B and Part D premiums. Unlike marginal tax brackets, where only the income above a given threshold is taxed at a higher rate, IRMAA operates as a cliff. This means that exceeding a threshold by even one dollar results in the full surcharge for that bracket being applied. Even financially experienced retirees can be caught off guard if their income unexpectedly rises above a threshold.

Adding further complexity, IRMAA surcharges are determined each year based on Modified Adjusted Gross Income (MAGI) from two years prior, since that is the most recent tax filing available. For example, the surcharge applied at age 65 is based on income from the calendar year in which a person turned 63. This two-year lookback means that financial decisions made well before Medicare enrollment—such as Roth conversions, capital gains realizations, or Social Security claiming strategies—can carry meaningful consequences.

It is also worth noting that IRMAA income thresholds differ from those used for IRS marginal tax brackets. A common tax planning approach involves “filling up” a tax bracket by recognizing additional income through strategies like Roth conversions. However, failing to account for IRMAA thresholds in this process can inadvertently push income over a cliff, resulting in hundreds or even thousands of dollars in higher annual premiums.

Several strategies can help manage IRMAA exposure. Qualified Charitable Distributions, for instance, allow retirees to direct Required Minimum Distributions to charity without increasing their Adjusted Gross Income—unlike standard charitable deductions, which reduce taxes but do not lower MAGI. Additionally, timing Roth conversions at least two years prior to Medicare enrollment can be advantageous, as the resulting income will fall within the lookback period before surcharges take effect.

Delaying Social Security is another factor that involves trade-offs. While it reduces current income and may help keep IRMAA thresholds in check in the near term, the larger benefit payments that result from delayed claiming could coincide with Required Minimum Distributions in later years, potentially pushing income into surcharge territory. These interdependencies illustrate why retirement income planning calls for a coordinated, multi-year strategy.

Medigap vs. Medicare Advantage

In addition to income planning, retirees face another important decision: choosing between Medigap (also known as Medicare Supplement Insurance) and Medicare Advantage. This choice is shaped not only by an individual’s healthcare needs but also by the financial risk profile of their retirement plan. From a financial planning standpoint, the decision centers on risk tolerance, lifestyle preferences, and the desire for cost predictability.

Medigap works alongside Original Medicare (Parts A and B) to help offset out-of-pocket costs such as deductibles, coinsurance, and copayments. Monthly premiums tend to be higher—ranging from approximately $32 to $550 depending on the plan and geographic location—but out-of-pocket costs are lower and more consistent.

Medicare Advantage, by contrast, serves as a comprehensive alternative to Original Medicare. Offered by private insurers, these plans often bundle dental, vision, and hearing benefits and typically feature lower premiums, which can make them appealing at first glance. However, they generally come with higher potential out-of-pocket costs subject to annual caps, network restrictions, and referral requirements that could result in denied care in certain situations. Retirees should also consider the potential difficulty of switching back to a Medicare Supplement plan at a later date due to medical underwriting requirements.

Medigap is characterized by higher fixed costs and more predictable total healthcare spending—akin to paying a higher insurance premium for broader coverage. It also provides nationwide access to care, which is a meaningful advantage for retirees who travel frequently. Medicare Advantage, on the other hand, offers lower initial costs but introduces greater variability in annual healthcare expenditures, particularly for individuals managing chronic conditions or who experience unexpected medical needs.

For retirees with substantial Health Savings Account balances or other dedicated healthcare reserves, the variable costs associated with Medicare Advantage may be manageable. For those who value budget certainty or who require frequent medical care, the predictability of Medigap may justify the higher premium. In 2025, the average beneficiary had access to 42 Medicare Advantage plans, underscoring the importance of carefully evaluating options each year.

Monitoring personal circumstances and policy updates

Medicare planning is not a one-time event. It requires annual review because plan options, premiums, health status, and income levels are all subject to change. Staying informed about policy developments—such as adjustments to IRMAA thresholds or definitional changes—is equally important. Unlike more stable financial goals such as saving for education, healthcare expenses are inherently variable and tend to rise with age, making ongoing review an indispensable component of any retirement plan.

Additional considerations worth keeping in mind include:

• Timing is critical. Missing the Initial Enrollment Period—a seven-month window centered around one’s 65th birthday—can result in a permanent 10% penalty on Part B premiums for every year of delay, unless the individual qualifies for a Special Enrollment Period through active employment.
• Limited long-term care coverage. Medicare provides only limited long-term care support under specific conditions, such as a qualifying hospital stay followed by admission to a Medicare-approved skilled nursing facility for a condition expected to improve. This comes as a surprise to many beneficiaries.
• Life events can impact costs. Significant life changes—such as job loss, divorce, or the death of a spouse—may trigger a reassessment of IRMAA surcharges, potentially reducing premiums if income has declined.

When Medicare is navigated thoughtfully, it can serve as a foundation for a more secure and financially predictable retirement. The key lies in proactive planning—developing a thorough understanding of the program’s complexities well in advance of enrollment decisions.

The bottom line? Medicare decisions carry significant implications for retirement income, taxes, and overall financial planning. Understanding the program’s structure, planning around income thresholds, and selecting the right coverage are all essential steps toward protecting savings and maintaining financial well-being throughout retirement.

References

1. https://data.cms.gov/summary-statistics-on-beneficiary-enrollment/medicare-and-medicaid-reports/medicare-monthly-enrollment

Advisory services are offered through Collective Wealth Advisors LLC, a Registered Investment Adviser with the SEC. For informational and educational purposes only and should not be construed as specific investment, accounting, legal, or tax advice. Certain information is based upon third party data which may become outdated or otherwise superseded without notice. Third party information is deemed to be reliable, but its accuracy and completeness cannot be guaranteed. Neither the Securities and Exchange Commission (SEC) nor any other federal or state agency have ap- proved, determined the accuracy, or confirmed the adequacy of this article.