Converting to Roth and Harvesting Capital Gains Under Obamacare ACA Premium Subsidy

Senior couple signing financial contract

I posted this chart in the previous post Stay Off Obamacare Premium Subsidy Cliff.

It looked at the sudden jump in the net health insurance premium once your income goes above the premium subsidy cliff set at 400% FPL. This time we zoom in and take a closer look at the part of the chart when your income is below 400% FPL.

Suppose a married couple retired early and their modified adjusted gross income (MAGI) is $20k from interest, dividends, and capital gains. Should they convert some pre-tax money in their Traditional IRA to Roth in order to take advantage of their low tax rates?

Long-term capital gains are taxed at 0% for taxpayers in the 10% and 15% tax brackets (AGI up to $94k in 2014 for married filing jointly taking the standard deduction and two personal exemptions). Should they intentionally realize some more long-term capital gains when those gains are taxed at 0%?

They should if they have health insurance elsewhere. Things get more complicated when they buy health insurance on the exchange under Obamacare.

300% FPL bend point

Zooming in shows there is a slight bend in the line at 300% FPL.

This is because the deemed affordable premium as a percentage of income increases until your income reaches 300% FPL. Then it levels off at 9.5% of income between 300% FPL and 400% FPL.

Income Affordable Premium
up to 133% FPL 2.0% of MAGI
133-150% FPL 3.0 – 4.0% of MAGI
150-200% FPL 4.0 – 6.3% of MAGI
200-250% FPL 6.3 – 8.05% of MAGI
250-300% FPL 8.05 – 9.5% of MAGI
300-400% FPL 9.5% of MAGI
above 400% FPL full cost

Extra Tax From Losing Tax Credit

Between 300% FPL and 400% FPL, when you add income by converting to Roth or realizing capital gains, your affordable premium increases by 9.5% of the extra income. Losing 9.5% in tax credit is equivalent to adding 9.5% to your marginal tax bracket.

Between 300% FPL and 400% FPL, the money you convert to Roth in the 15% tax bracket becomes taxed at 24.5%. Realized long-term capital gains which normally would be taxed at 0% become taxed at 9.5%.

When your income is below 300% FPL, the loss of tax credit due to extra income is higher, at about 15% of the extra income. The money you convert to Roth in the 10% tax bracket becomes taxed at 25%. The money you convert to Roth in the 15% tax bracket becomes taxed at 30%. Realized long-term capital gains which normally would be taxed at 0% becomes taxed at 15%.

Here’s a 2×2 matrix to summarize the impact:

MAGI Convert to Roth Long-Term Capital Gains
Below 300% FPL ~25-30% ~15%
300% – 400% FPL 24.5% 9.5%

The first $20k or so in income is still tax free. It’s offset by the standard deduction and personal exemptions. It also takes you right up to the point where you become eligible for the premium subsidy (100% or 138% FPL). After that, you pay 25% to 30% tax on Roth conversions and 9.5% to 15% tax on realized long-term capital gains.

There’s an added cost on converting to Roth and harvesting long-term capital gains when you are getting the premium subsidy to buy health insurance under Obamacare. Considering that you are getting a large subsidy though, it’s still not bad.

It’s better if you are able to convert to Roth or harvest long-term capital gains before you get on the exchange (say when you have a part-time job that provides health insurance), or you do so in a year when you don’t get the premium subsidy anyway, as I wrote in the previous article Income Bunching Under Obamacare.


Please read these related articles in the series about the Affordable Care Act:

[Photo credit: Flickr user SalFalko]

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  1. John says

    When I retire, I think my new full time job will be managing my taxable income to work within all of these rules! Thanks for laying it out for us. Nice job.

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