Stay Off the Obamacare Premium Subsidy Cliff

The Cliffs of Moher ~

I’m not buying health insurance on the exchange under Obamacare just yet because I’m still working and getting health insurance through my employer. I still looked at the premiums offered on the exchange. When I retire I will buy health insurance on the exchange before Medicare kicks in.

Before Obamacare, getting health care coverage is one of the biggest challenges for retiring early. Forget about the cost; just getting a policy is a challenge by itself. Obamacare changed all that. Now early retirees can buy health insurance on the exchange.

400% FPL Cliff

Not only are you able to buy health insurance, the coverage is also made affordable by the premium subsidy in the form of a tax credit. Whether you get the Premium Tax Credit for buying health insurance on the exchange depends on whether your modified adjusted gross income (MAGI) exceeds a critical cutoff point at 400% Federal Poverty Level (FPL). See previous post for where 400% FPL is at for your family size.

Your MAGI for the purpose of Obamacare is basically:

  • your gross income;
  • minus pre-tax deductions from your paycheck (401k, FSA, …)
  • minus above-the-line deductions;
  • plus tax-exempt muni bond interest;
  • plus untaxed Social Security benefits

Wages, interest, dividends, capital gains, pension, withdrawal from traditional 401k and IRAs, money you convert from Traditional to Roth accounts all go into MAGI. Otherwise-not-taxed muni bond interest and Social Security benefits also count in MAGI.

If your MAGI is at 400% FPL or below, you get a tax credit (subsidy) equal to the difference between a percentage of your MAGI and the cost of the second least expensive Silver plan. The tax credit goes down as your income increases. It disappears when your MAGI goes above 400% FPL. If your MAGI is $1 above 400% FPL, you pay the full premium with no tax credit.

For my age and family size, it means a difference of more than $4,000 in tax credit. Because the health insurance premium is higher for older folks, so is the tax credit for someone older with the same MAGI. For someone 10 years older than I, that difference becomes more than $10,000. When I retire, I definitely want to keep my income under 400% FPL.

This chart shows the health care premium I would pay for a family of two at different income levels if I were to buy a Silver policy now:

You see the big jump at income slightly above $60k for a family of two, caused by losing the tax credit once your MAGI goes above 400% FPL.

Staying Under the Cliff

Fortunately it’s relatively easy to stay under the cliff for early retirees.

When you retire early, before 59-1/2, you are primarily spending money from your taxable accounts. A large part of the money withdrawn is your own savings; the rest are interest, dividends, and capital gains. Spending your own savings isn’t income. If you withdraw $60k to live on, your MAGI isn’t $60k. It’s probably less than $30k.

If you keep a part-time business that generates income after you retire, it makes sense to keep maxing out contributions to traditional 401k, IRA, and HSA even though you already retired. Those tax deductible contributions lower your MAGI, which helps you stay under the 400% FPL cliff. Withdraw living expenses from taxable accounts.

This also means that, for early retirees, living in an area with low cost of living and low state tax is ever more important than before. Low cost of living and low state tax means you will need to withdraw less from your accounts, resulting in less income and a lower out-of-pocket health insurance premium.

100% and 138% FPL Cliff

There is another cliff on the low side, although that one is easily overcome.

In order to qualify for premium subsidy for buying insurance from the exchange, you must have income above 100% FPL. In states that expanded Medicaid to 138% FPL, you must also not qualify for Medicaid, which means you must have MAGI above 138% FPL.

If you see your income is at risk of falling below 100% or 138% FPL, just convert some money from Traditional to Roth. That’ll fix it. Just remember to do it before December 31.


The Premium Tax Credit, IRS

[Photo credit: Flickr user **Mary**]

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  1. ameridan says

    Great writeup! Nice to have a well-thought-out reference. I retired at 52 and did the 72t. Fortunately now that I’m 60 I can decide on how much to withdraw from IRA accounts, because I would have been over the cliff with no means of changing the withdrawal amounts. As you state, I’ll just use taxable savings to supplement my pension for a few years now.

  2. Michael says

    You state that money converted from traditional to Roth accounts is part of MAGI.

    Later you state that spending your own savings is not income.

    Why isn’t money converted to a Roth (saved money on which taxes were paid) treated the same?

    • Harry says

      Sorry if it wasn’t completely clear. As you are converting pre-tax money from Traditional to Roth, that conversion is taxable, and it is in part of your MAGI in the year you convert. After you already converted, withdrawing from Roth accounts after 59-1/2 isn’t taxable and it’s not part of your MAGI when you withdraw. I was referring to the former, not the latter.

  3. bp says

    What? An Obamacare article that doesn’t blindly bash or praise, but looks rationally on how it might actually affect people. Good work.

    I agree; health insurance surely has been one of the more daunting challenges for folks who are looking to retire early. Thanks for clarifying how early retirees can use this policy to their (further) advantage.

  4. Evan says

    While the information in this post is accurate, it shows just how ridiculous ObamaCare really is.

    I am self-employed and have paid for my own individual Blue Cross policy for over 10 years now. It is a high deductible plan with a HSA option. I am still in my early 40’s and in very good health, so the premiums have been affordable. And I have fortunately never actually used the insurance in the 10+ years I have had it.

    With the implementation of ObamaCare next year, my plan is no longer a benefit compliant plan, and the replacement options with Blue Cross will increase my current premiums by about 300%. Therefore, I have looked at the exact scenario Harry outlines above. I can just move to an exchange plan, manipulate my income down to qualify for subsidies, and possibly even pay less than I do now for improved coverage.

    Do I want to do that? No, I hate the idea of ever being on the government dole as I have never been in my life. But with the government negating my existing policy and artificially increasing my existing premiums thru ObamaCare, the incentive is obviously there.

    If I choose to do this, it will actually increase the liability of my healthcare cost to other taxpayers. Just as Harry, who pretty clearly could afford his own insurance even at age 55-65, will therefore also shift more of his medical cost onto taxpayers.

    Wise economically for such individuals, but terrible public policy.

    • Harry says

      “Just as Harry, who pretty clearly could afford his own insurance even at age 55-65, will therefore also shift more of his medical cost onto taxpayers.”

      I don’t know about that. Health care is very expensive. I tried adding 10 years to my age. The $4,000 tax credit at the edge of the cliff becomes $10,000, and that’s based on today’s prices. As you know medical costs have been going up faster than inflation. I don’t think I will be able to afford it without the credit. I thank the taxpayers for helping me out. I have been helping other taxpayers (and non-payers) with my fair share all these years.

    • Evan says

      Just saw this this morning. Senator Susan Collins of Maine is pushing for means testing of the ObamaCare subsidies as one condition in a plan to reopen the government. Which would make this entire post no longer relevant.

      Will means testing happen? Probably not this year, but I can’t see how it won’t in pretty short order. Anyone that believes and plans on receiving health care insurance subsidies based on lower income, while still maintaining substantial wealth, is likely to be disappointed.

    • Harry says

      The news report I read says “income means testing” which is already in the ACA, not “assets means testing.” I don’t know what exactly Sen. Collins is proposing. Proposals, however, are a dime a dozen in Washington. We will deal with it when something is passed by both houses and signed into law by the President. It will give opportunity for more blog posts!

  5. Michael says

    This is a little off-topic, but… Aside from helping out the early-retired, I think an underappreciated aspect of Obamacare might be its effect on stimulating entrepreneurship. Yes, one could argue that requiring employers of 50 or more to provide health insurance coverage could negatively impact small businesses, an alternative view would be that not having to worry about where they’ll get health insurance could prompt more people to go out and start a business vs. sticking with their regular job due to keep their insurance.

    • harold says

      Are you frickin serious???????????????? You seriously think obamacare will stimulate entrepreneurship?????????????????

      Did you actually look at that chart? Don’t make more that a little over $60k or you’re screwed – thanks to obamacare. Way to bring down American entrepreneurship.

      Seriously! Have ANY of you read any history books?????????????? Socialism/communism does NOT work! Do the frickin math!

      Who educated (propagandized) you people? I guarantee you there isn’t a single person who supports obamacare who has EVER lived in a socialist/communist country. Educate yourselves and quit being seduced with this b.s.

    • Harry says

      harold – I don’t know. Lack of a subsidy doesn’t make one worse off than before. I get Evan’s point about certain low-cost bare bones policies are off the market now. Some are forced to spend more to buy something better. Anyway, there are plenty of debates about the merits and the dismerits of Obamacare. This is not the right place for that debate. It’s for looking at the lay of the land and seeing what we make of it.

    • Elenor says

      Michael is apparently not a small business owner! I inherited my husband’s business in 2011. After a very hard and dicey half year trying to get it back up and running (a small manufacturing company; and there were parts I did not know how to make, subcontractors I could not get to perform), I’m now on a path to survivability. (Not safe yet, hoping I see it coming!)

      As both the owner and employee of an LLC (operating as an S Corp), the $23,000 I paid myself in 2013 would not come CLOSE to allowing me to pay for Obamacare, and since the company had a profit of $64k — and the govt counts that as “my” income ( except, of course, I can’t withdraw and spend it without killing the company!), I certainly could not describe ObamaCare as having any: “effect on stimulating entrepreneurship”! No subsidy for the $64k; no possibility of affording premiums on $23k… so where’s my entrepreneurial stimulation?! (Unless you count the frantic panic as I tried to figure out what to do: That’s been stimulating, but not in a good way!)

      The cheapest bronze plan I could find would have cost nearly $7k in premiums, with a $6k deductible. (I’m 58.) So, for that $11k in 2014 Obamacare coverage — if the kidney stone I had in 2012 had happened this year, I would not have gotten one (very!) red dime in insurance coverage! And the $8k that took nearly a year to pay off ONLY covered diagnosis (a night in the ER, tests, drugs); but NOT any treatment! They referred me to a doctor, but I couldn’t possibly pay for anything more. Thankfully the pain drugs allowed me to live through the excruciating couple of weeks of the *#&@&* stone making its way out… and I was fer shure praying for no complications, because that would have bankrupted both me and the company.

      So yeah, you betcha, Michael — CommieCare REEEEALLY helps this entrepreneur!

      Thankfully, as it turned out, when I jumped through hoops and pretty much begged, I managed to get admitted into the VA health care system. Seems I “made too much” to be admitted — but since I had served for six years as an officer (back in the 70s-80s), they finally “had” to let me into the system. I can’t actually GET health care from the VA (there are lots of maimed kids and older vets who, rightly, come ahead of me in line for care), but I cling to the hope that if something serious goes wrong, I might be able to get seen… But at least I only have to pay a boatload of taxes for OTHER people’s CommieCare — and not penalties or completely destructive premiums for “my” insurance.

    • Harry Sit says

      Sorry to hear your loss Elenor. Would switching the business to a C Corp help?

  6. Mike Piper says

    Nice explanation. :)

    My understanding is that in addition to the premium subsidy cliffs, there are also cliffs at 150%, 200%, and 250% of FPL with regard to the cost-sharing subsidy.

    • Harry says

      Mike – That’s true. It’s a big topic. We will have to take one small bite at a time.

      KD – The value of low deductible, low co-pay, and low out-of-pocket maximum of course depends on how much you use the insurance. As you said, when you are older and you need more service, the low cost-sharing becomes more valuable. Hopefully you remain healthy and you make it a non-issue. Otherwise directionally I would say if you can live on much less income than 400% FPL now, convert some money to Roth and push toward it. Save the low income years for the future when you need the low cost-sharing.

  7. indexfundfan says

    What are the last minute things that you can do to reduce the MAGI for the purpose of ACA subsidy? Say, it is 12/26/14 and you just estimated that your MAGI is hitting the income cliff.

    It seems like the place to look at are the “above-the-line” deductions. Are charity donations going to help?

    • Mike Piper says

      Yes, above the line deductions.

      So, no, charitable contributions will not help.

      Things like HSA contributions, pre-tax 401(k) contributions, and deductible IRA contributions would help.

    • Harry says

      No, charity donations are below the line. Above-the-line deductions include among other things HSA contributions, self-employment retirement contributions (solo 401k, SEP-IRA), deductible traditional IRA contributions, and tuition and fees.

    • indexfundfan says

      Thanks guys.

      Most of the above-the-line deductions are hard to generate in the last minute if you are not self-employed.

      One interesting item I see is the penalty for early withdrawal from savings, which I guess would include CDs.

      Is the income cliff that steep such that paying say $100 in early withdrawal penalty would net you more than $100 increase in subsidy?

    • Harry says

      I think the deductible traditional IRA contribution is a good lever. If someone contributed to Roth because of lower income and lower tax rates, recharacterize to traditional. It’s deductible at that income level. CD early withdrawal penalty is useful only if you are right at the cliff. Low interest rate means low penalty. You’d have to withdraw a lot early in order to generate a meaningful penalty. But if it comes to that, sure. The chart shows if you are $1 over, you lose $4,000 in tax credit (for my age group in my area).

    • indexfundfan says

      If a person has ready cash, I think the person can generate as much penalty as he/she likes — open the CD on day one and break on the next day. You will pay a high penalty if the CD term is long.

      However, the person needs to check the terms carefully that the institution will not deny a person from breaking a CD within a certain amount of time.

      Obviously if putting money into the deductible IRA is available, paying a CD penalty is much less favorable.

  8. Stuartf says

    I see conflicting info on “household income”. Can a married couple (one on Medicare and one not) file married/separately and get the exchange customer under the $46000 MAGI level?

    • Harry says

      If you under-estimate your income to make it below 100% FPL or 138% FPL in states that expanded Medicaid, you will be denied the premium subsidy advance. Then you will get the subsidy back when you file your taxes. If you under-estimate your income to make it below 400% FPL but your actual income is over 400% FPL, you will have to repay the premium subsidy advance when you file your taxes. If you under-estimate your income but your actual income isn’t over 400% FPL, you will have to repay some, but not necessarily all, of the premium subsidy advance when you file your taxes.

      If you over-estimate your income to make it above 100% FPL or 138% FPL but your actual income isn’t, you repay some, but not necessarily all, of the premium subsidy advance when you file your taxes. If your over-estimate your income to make it above 400% FPL, you will be denied the premium subsidy advance. Then you will get the subsidy back when you file your taxes. If you over-estimate your income to a point still below 400% FPL, you will get additional premium subsidy when you file your taxes.

  9. S. B. says

    Nice write-up. It does appear to be a “cliff” due to the fact that the credit was not appropriately phased out gradually at the cutoff level. For some people, I’m thinking this will make the marginal tax rate at the cutoff very, very high.

  10. Dennis says

    Hi Harry,

    Does a “capital loss” from a state’s tax-exempt municipal bond index fund bring down your MAGI?

    Great article!

    • Harry says

      As usual, realized capital loss first offsets realized and distributed capital gains, which reduces gains added to your MAGI. If you have more losses than gains, you can bring down your income by up to $3,000. Any additional losses are carried over to the next year.

  11. sharon says

    When you report income for obamacare do you only report when you withdraw from any of your savings like CD`S,Roths, and other investments?

    • Harry says

      You report all your income. Interest earned on your savings is income, whether you withdraw or not. However, withdrawing from your own savings or from Roth accounts (if you meet qualifications) isn’t income.

  12. Jim says

    Great article. One quick comment…

    It is my understanding that a 401k (whether employer or individual) is deducted before calculating your ACA credit, but an IRA is not. Can someone clarify that?

    • Harry says

      Not exactly. Traditional 401k contributions are excluded from your income; Roth 401k contributions are not. Deductible contributions to a traditional IRA reduce your MAGI; non-deductible contributions and Roth IRA contributions do not.

  13. geoff boston says

    Thank you for the article. The only intelligent answer on the net to the question of Obamacare MAGI and tax free municipal bond interest. But I am now more depressed.

  14. sally davidson says

    I am confused I see different comments on a regular IRA
    On line I have seen that a 401k contribution is not added back to calculate MAGI but a regular self funded IRA is What is true? ??

    • Harry Sit says

      Of course what I say is true. There is no adding back for either. Pre-tax 401k is taken out before your W-2 income. Your deductible IRA contribution is an above-the-line deduction, which comes before your AGI is computed. Only add back non-taxable muni bond interest and Social Security benefits.

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