If you buy health insurance from healthcare.gov or a state-run ACA exchange, whether you qualify for a premium tax credit is determined by your income relative to the Federal Poverty Level (FPL). You don’t qualify for a premium tax credit if your income is above 400% of FPL. That’s a hard cutoff. See Stay Off the ACA Premium Subsidy Cliff.
If you do qualify for a premium tax credit, how much credit you qualify is determined by a sliding scale set each year by the government. The government says based on your income, you are supposed to pay this percentage of your income toward a second lowest-cost Silver plan in your area. After you pay that amount, the government will take care of the rest. If you pick a less expensive policy than the second lowest-cost Silver plan, you keep 100% of the savings. If you pick a more expensive policy than the second lowest-cost Silver plan, you pay 100% of the difference.
That sliding scale is called the Applicable Percentage Table. The numbers are adjusted each year. In 2020, people with income between 300% and 400% of Federal Poverty Level are expected to pay 9.78% of their income toward a second lowest-cost Silver plan in their area. That number is going to change to 9.83% for 2021.
Here are the numbers for different income levels in 2020 and 2021:
| Income | 2020 | 2021 |
|---|---|---|
| < 133% FPL | 2.06% | 2.07% |
| < 150% FPL | 3.09% – 4.12% | 3.10% – 4.14% |
| < 200% FPL | 4.12% – 6.49% | 4.14% – 6.52% |
| < 250% FPL | 6.49% – 8.29% | 6.52% – 8.33% |
| < 300% FPL | 8.29% – 9.78% | 8.33% – 9.83% |
| <= 400% FPL | 9.78% | 9.83% |
Source: IRS Rev. Proc. 2019-29, Rev. Proc. 2020-36
As you see from the table above, the changes between 2020 and 2021 are quite minimal. The percentage of income the government expects you to pay toward a second lowest-cost Silver plan depends on your income relative to the Federal Poverty Level. To calculate where your income falls relative to the Federal Poverty Line, please see Federal Poverty Levels (FPL) For Affordable Care Act (ACA).
If your income is low, they expect you to pay a low percentage of your low income. As your income goes higher, they expect you to pay a higher percentage of your higher income. The higher percentage applies not just to the additional income but to your entire income. A higher income times a higher percentage is much more than a lower income times a lower percentage. For example, a household of two in the lower 48 states is expected to pay 7.82% of their income when their 2020 income is $40,000. If they increase their income to $50,000, they are expected to pay 9.66% of their income. The increase of their expected contribution toward ACA health insurance, and the corresponding decrease in their premium tax credit will be:
$50,000 * 9.66% – $40,000 * 7.82% = $1,702
This represents 17% of the $10,000 increase in their income. For a married couple, the effect of paying 17% of the additional income toward ACA health insurance is greater than the effect of paying 12% toward federal income tax. Normally it’s a good idea to consider Roth conversion or harvesting tax gains in the 12% tax bracket, but those moves become much less attractive when you receive a premium subsidy for ACA health insurance. For a helpful tool that can calculate this effect, please see Tax Calculator With ACA Health Insurance Subsidy.
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Eric Gold says
Well written and reasoned. (Disclaimer: I came to these same conclusions.)
All the more reason to choose IRA over Roth
Personal anecdote: I have not paid income taxes or health insurance premiums for years. The bulk of the strategy is downright simple:
1. Keep taxable income below ~ $45 – 50k a year by sending my excess income to a variety of deferred taxation retirement plans.
2. Choose a HD bronze ACA plan to offset some of my taxable income.
3. Have a healthy lifestyle so that the silver and gold plans are a waste of money.
Brian says
A very informative and thorough article. Our ACA story—>
When my wife and I retired in 2010, we still had 10 years to go before we were Medicare eligible.
– During the first 3 years of retirement (2011/2012/2013), we enrolled in our previous employer’s retiree medical plan. The monthly premiums were quite high and increased each year —> $700 to $800 to $900.
– Then, in 2013 as the ACA was about to roll out, I happened across this article:
https://money.usnews.com/money/blogs/on-retirement/2013/11/11/the-obamacare-trick-early-retirees-should-know
– In 2014 when the ACA came out, by tax-efficiently pulling from our various residents investment buckets, we were able to keep our MAGI low enough to qualify for Silver Plan subsidized premiums at less than $300/month at first. (When we finally figured out what we were doing, by 2017 our premium was down to $85/mo.; in 2018 it was $108/mo.) Using Silver plans rather than Bronze (or Gold) plans, we were also able to take advantage of the cost share reductions (i.e., CSR subsidies) of the deductibles, co-pays, and co-insurance.
Later in 2014 we came across another similar article, which reinforced what we were doing and gave us more understanding about how to maintain a low MAGI:
https://www.forbes.com/sites/carolynmcclanahan/2014/11/14/how-early-retirees-can-get-cheap-health-insurance-through-obamacare/amp/
Then, in 2016 we came across this article, making it clear that more people besides us were rearranging their wealth and doing the same thing:
https://www.cnbc.com/amp/2016/01/27/theyre-millionaires-and-they-get-obamacare-subsidies.html
We did this for five years (2014-2018). We were able to keep our MAGI low for all those years: in 2014 at 171% of the FPL; in 2015 at 162% of FPL; in 2016 at 212%; 2017 at 291%; and 2018 at 190%.
(In 2017 we had to pay back some of the advance premium tax credit because our income overshot our estimate. But, because of the repayment limitations, as well as the CSRs, we didn’t have to pay back all of the subsidies that we had benefitted from.)
We’ve calculated that if we had to purchase those same ACA health insurance plans (all were the SCLSPs) we selected without the subsidies, it would have cost us about $63,000 more in premiums over that same five-year period. (In which case we would’ve simply stayed with our previous employer’s retiree medical plan (RMP).)
There’s been (and still is) much political wrangling over the ACA. The first two years, we weren’t able to “keep our doctors.” Besides that, the ACA has worked out very well for us.
Brian says
A few typos and errors in the above; still, it’ll work…..
Pete says
Hi Harry,
This chart really illustrates the complexity of tax planning taking into account ACA premium subsidies. If I have the math correct, a family of 2 could have about $25,000 in income and pay only approximately $784 in ACA premiums and zero income tax. Of course $25,000 income would be “zeroed out” by the standard deduction. Add a Roth conversion of approximately $19,000 and one still stays in the 10% tax bracket and generates a bargain tax of $1,900. But that brings income up to 250% of poverty level and increases ACA premiums by about $2,000. Now the decision whether to do conversions is not so clear. My instinct is to not do the conversion, minimize taxes, and take the maximum subsidy while it still exists. Depending on the size of one’s deferred accounts this may or may not be optimal.
KD says
There is another wrinkle. Actually, max subsidy should not be the goal in itself. The minimizing the total healthcare outlay (premiums + out-of-pocket cost) with max available conversion space should be the goal. Based on your low healthcare expenditure, an HSA-eligible bronze plan with zero dollar premium may still result in acceptable outcome. Tax savings from HSA will more than cover the “extra” out-of-pocket costs compared to a highly subsidized plan. It will also help increase room for trad-to-Roth conversion space. Nothing is straight forward here. Take your time to understand the ins and outs by playing with the spreadsheet Harry has linked in his post.
ERIC LANCE GOLD says
1+ to KD
Ferhan Patel says
Hi Harry,
Well written and helpful article.Thanks for sharing.
Edward says
I’m going to jump in with something I discovered yesterday…
Users of HRBLOCK’s self-directed tax software, beware: the program does NOT adequately understand or deal with the implications of the ObamaCare “cliff”. (This is the “magic AGI number”: if you are below the number, the Federal government will help you pay for Medical Insurance; if you are above, you get ZERO. The difference is substantial. In my case, it was $10000.)
The problem for me was that they did not catch the fact that my numbers were straddling the cliff or that one of the choices it offered to me (on a completely unrelated topic) could make the difference for me. In fact, it chose the WRONG option by default and never mentioned the possibility that a different option would save me.
What was the option, you ask? I am paying for my kid’s college tuition and have the choice of taking one of 2 tax credits, or a third choice, a tax deduction. HRBlock defaults to the tax credit but, in may case, (and if you are close to the “Cliff”), the deduction could be much better for you.
Clearly, an oversight on their part, so beware. They (and probably other tax packages) probably don’t really worry about the Cliff, as so few people can be effected by it and it’s not worth their time to build it into their software.
Of course, contributing to a Trad IRA can also help get you below the cliff (and also was not pointed out by the tax software). In my case, I needed both of these tricks.
Harry Sit says
In their defense, H&R Block, TurboTax, and other tax software are designed as an after-the-fact reporting tool, not a decision recommendation planning tool. By the time most people use the tax software, many transactions already happened and you can’t change them. You only have very limited room to maneuver, such as contributing to Traditional IRA versus Roth IRA, or in your case taking the tuition deduction versus the tax credit. Even then, the software isn’t going to tell you which way is better. It expects you to make the choice by experimenting both ways. The software only follows your choices.
You can use tax software as a planning tool, but only if you take the initiative, ideally before the end of the year when many things still can be changed.
Brian says
True. The tax programs don’t appear to go as far as tracking that or warning of the best options to avoid those “cliffs.” (I use TurboTax.) Not sure if it’s an oversight or that basically, they’re just tax preparation programs, not tax planning programs.
We had a similar experience. We kept close track of those 200%, 300%, and 400% FPL thresholds (in addition to the related repayment limitations) in a separate spreadsheet. (Plus, we used the previous year’s tax program to estimate the current year’s projected income and spending.) That way, we were able to continuously track our modified AGI to ensure that we didn’t mistakenly go over a “cliff.”
The programs do allow you to do “what if” scenarios. But, I don’t know if they go to the level of detail that you were looking for.
Edward says
And to be even fairer, 2020 was a heck of a year to try to plan for! In my case, I had to predict not only my wages, but also that of my dependents, along with their possible unemployment benefits (which effected *my* Cliff situation)! Frankly, I don’t think it was possible to predict so many variables or take any defensive action. (Well, maybe some proactive tax loss harvesting…)
Still, don’t you agree that it would not be too much extra work for the HRBlock software to notice a “potential Cliff situation” and warn/advise the user to experiment with some options? It’s frustrating to me that, had I not rolled up my sleeves to take a look at the possibilities, I would have been $10K poorer.