Retirement Income

There is an ideology shared by almost every person in the country when it comes to retirement income: the more of it you have, the better off you will be.

The logic is simple, and on the surface it appears to be sound — everyone can agree that having more is always better. In retirement, though, things are different when it comes to income, and the difference exists solely because of regulations passed by Congress over the years.

Those regulations mean that how you generate income in retirement matters just as much as how much you generate. Two retirees with identical lifestyles and identical spending can pay dramatically different amounts in taxes and Medicare premiums, purely because of where their income comes from.

There are three specific federal regulations you need to be aware of before retiring:

1. Your Social Security Benefit Can Be Taxable

Under current federal regulations dating back to 1984, if you are generating too much income (measured by your adjusted gross income, or AGI) while receiving Social Security, up to 85% of your benefit can be taxable. The "wrong type" of retirement income leads directly to keeping less of your Social Security benefit.

2. Your Medicare Part B and Part D Premiums Can Increase (IRMAA)

Starting in 2007, anyone in Medicare who generates too much income — measured by Modified Adjusted Gross Income (MAGI) — is subject to means testing through the Income-Related Monthly Adjustment Amount, or IRMAA. IRMAA functions like a tax collected through Medicare: if your income crosses the thresholds, your Part B and Part D premiums increase. The "wrong type" of retirement income leads to higher Medicare costs. You can see exactly where the thresholds fall on our IRMAA brackets page.

3. Your Social Security Benefit Pays Your Medicare Premiums

For most retirees, Medicare Part B premiums — and any IRMAA surcharges — are deducted automatically from the Social Security benefit. That means the "wrong kind" of retirement income will cost you even more of your Social Security check than you may be planning for: first through taxation of the benefit itself, and then again through higher premiums withheld from it.

Once you factor in these Congressional regulations, you realize there are really only two types of retirement income:

1. The "wrong kind" of retirement income — income that increases your ordinary income taxes, lowers your net Social Security benefit, and can increase your Medicare premiums.
2. The "right kind" of retirement income — income that is not taxable, so you pay little to no tax on it, your Social Security benefit will most likely never be taxable, and you will not reach IRMAA.

The easiest way to tell the difference between the two:

• The "right kind" of retirement income is income from assets you have already paid taxes on.
• The "wrong kind" of retirement income is income from assets on which you are promising to pay taxes later, when you are in retirement.

The benefits of paying taxes today, while you are working and can afford them, often far outweigh delaying taxes until retirement, when you are no longer working and need every dime you have.

The "wrong kind" of retirement income is any income that the Internal Revenue Service (IRS) and the Social Security Administration (SSA) use to determine your adjusted gross income (AGI). AGI allows the IRS and SSA to determine three specific things:

• How much you will owe in ordinary income taxes.
• How much of your Social Security benefit will be subject to taxation.
• Whether you reach Medicare's IRMAA — and if you do, your Medicare Part B and Part D premiums increase even higher.

This type of income comes from investment vehicles that utilize tax-deferred contributions, as well as any other income you earn while in retirement that is taxable. Common examples include:

• Taxable Social Security benefits
• Wages
• Interest
• Capital gains
• Dividends
• Pension and rental income
• Withdrawals from tax-deferred assets like a traditional 401(k), IRA, or 403(b)

For Medicare purposes specifically, the figure that matters is MAGI — your AGI plus any tax-exempt interest. Our guide to Modified Adjusted Gross Income breaks down exactly what's included.

The "right kind" of retirement income is simply income you generate that the IRS does not include in your adjusted gross income (AGI). By having a very small — or even no — AGI, you will never be subject to significant ordinary income taxes, nor will you pay a large amount of taxes on your Social Security benefit.

This income comes from investment vehicles that utilize after-tax contributions:

• Roth accounts — qualified distributions from Roth IRAs and Roth 401(k)s are tax-free and excluded from MAGI.
• Cash value of life insurance — accessed through withdrawals of basis and policy loans.
• Non-qualified or Roth annuities — structured so distributions minimize reportable income.
• Health Savings Accounts (HSAs) — qualified medical withdrawals are entirely tax-free. See how Medicare and HSAs interact.
• 401(h) plans — a lesser-known vehicle for tax-free retiree medical benefits.
• Loans on your primary residence — borrowed funds are not income.

In retirement the key ingredient is income — but having the "wrong kind" of retirement income will only lead to much higher taxes and much lower net income. The goal for every retiree should be to have as little of the "wrong kind" of retirement income as possible, so they can maintain their lifestyle throughout their entire retirement.

Here's where the two kinds of income collide with Medicare. The SSA determines IRMAA using your MAGI from your tax return two years prior — so your 2021 income determined your 2023 premiums. The mechanics are covered in detail in How Is IRMAA Calculated.

When this article was originally published in 2023, the standard Medicare Part B premium was $164.90 per month, and IRMAA began for individuals with MAGI above $97,000 (or $194,000 for married couples filing jointly). Crossing a threshold by even one dollar moved a beneficiary into the next bracket — there is no phase-in. That cliff structure is exactly why the composition of retirement income matters so much.

The thresholds adjust each year, so always check the current IRMAA brackets when planning withdrawals. And if a life-changing event — retirement, divorce, death of a spouse — has reduced your income since that two-year-old tax return, you can appeal the determination using Form SSA-44.

Shifting from the "wrong kind" to the "right kind" of retirement income doesn't happen by accident — it takes deliberate, multi-year planning, ideally starting well before Medicare enrollment at age 65:

• Roth conversions: Converting traditional IRA or 401(k) balances to Roth creates taxable income now, but removes those dollars from AGI forever. Timing conversions before age 63 avoids the two-year IRMAA lookback entirely.
• Asset location: Holding income-producing investments in tax-advantaged accounts keeps interest, dividends, and capital gains out of AGI.
• Withdrawal sequencing: Coordinating which accounts fund each year's spending can keep MAGI under the IRMAA thresholds year after year. Our guide on how to reduce MAGI covers the levers in detail.
• HSA funding during working years: Building an HSA before Medicare enrollment creates a pool of fully tax-free dollars for healthcare costs in retirement.

For financial advisors, this is where planning software earns its keep. RetirementAdvisorPro models how each client's income sources flow into MAGI, projects future IRMAA exposure year by year, and quantifies how strategies like Roth conversions change lifetime Medicare costs — turning the "right kind vs. wrong kind" framework into a concrete, client-ready plan.

Retirement income is not one-size-fits-all. Because of federal regulations — Social Security taxation since 1984, and Medicare's IRMAA means testing since 2007 — the type of income you generate in retirement determines how much of it you actually keep.

Income from tax-deferred assets and other AGI sources gets counted three times over: in your ordinary income taxes, in the taxation of your Social Security benefit, and in the Medicare premiums deducted from that benefit. Income from after-tax vehicles — Roth accounts, HSAs, life insurance cash value — largely escapes all three.

The goal is not less income. It's less of the wrong kind of income — so more of every dollar you generate stays in your pocket, maintaining your lifestyle throughout your entire retirement.