The previous post Stay Off Obamacare Premium Subsidy Cliff showed that when you retire before age 65, ideally you should keep your income below 400% FPL so that you will qualify for the premium subsidy for purchasing health insurance. What if you need more income than that?
Suppose you are already over 59-1/2 and you are withdrawing living expenses from your pre-tax Traditional IRA. Say your expenses are higher than usual in one year and you need to withdraw more. That pushes you over the cliff and you lose the premium subsidy. Now what?
Now that you are already over, you should take a big bath and jack up your income some more. Convert some more money from Traditional IRA to Roth, to the top of the 15% bracket, or even to the top of the 25% bracket. For married filing jointly taking the standard deduction and two personal exemptions in 2014, the top of the 15% tax bracket is AGI $94k; it’s AGI $169k to the top of the 25% tax bracket.
With more money in Roth accounts, you make it easier to qualify for the subsidy in future years, because withdrawing from Roth accounts doesn’t add to your income. In future years, you withdraw less from your Traditional accounts and you withdraw more from your Roth accounts. You’d rather be over the cutoff in one year, way over, and be under the cutoff in the next several years, as opposed to being over the cliff in all years.
This is similar to deduction bunching, when you put more of your tax deductible expenses into one year and take the higher itemized deductions in alternate years.
This also means if you want to live on more income than the 400% FPL cutoff when you retire before age 65, it could be beneficial to build up your Roth accounts beforehand. A large Roth account will help you stay under the 400% FPL cutoff after you retire.
On the other hand, if the need for income is only temporary, it can make sense to borrow the shortfall, say from a HELOC, instead of taking additional withdrawals from your pre-tax IRA and pushing yourself over the cliff. Borrowed money does not count as income.
Please read these related articles in the series about the Affordable Care Act:
- Stay Off the Obamacare ACA Premium Subsidy Cliff
- Marriage Penalty Under Obamacare ACA Premium Subsidy
- Converting to Roth and Harvesting Capital Gains Under Obamacare ACA Premium Subsidy
- Effective Tax Rates Under Obamacare ACA Premium Subsidy
- Cost-Sharing Subsidy Under Obamacare ACA
- IRS Guidance On Circular Reference in Obamacare ACA Premium Subsidy and Deduction
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You have previously argued against Roth 401k for most people, and I had agreed with that stance. However, given your statement “A large Roth account will help you stay under the 400% FPL cutoff after you retire.”, I’m starting to question it and wonder if putting at least some of my 401k dollars into Roth would be a good idea now. This would give flexibility during retirement to choose what level of taxable income I’d want year by year by having the mixture to choose from.
Yes this weakens the case against Roth 401k if you are planning to retire before 65 and get health insurance under Obamacare. Then again you have to weigh the risk of laws changing, as noted by Evan in the comment below.
I would be very hesitant to follow this advice. Tax laws can always change in the future. In particular, a provision that allows income manipulation like this to earn large government subsidies is going to be a prime candidate to be abolished by either party in power. Nearly all other government welfare programs not only have income means testing, but means testing on wealth/assets as well.
If you are talking about pulling extra taxable income into 2013, and thereby being eligible for subsidies in 2014-2015, it probably makes sense to do. But if you are talking about converting to a Roth and playing large amounts of tax now because you might then be able to qualify for subsidies 5-10 years from now, I think it is a bad bet.
I stick with a simple premise – always defer income taxes unless there is a high probability of net savings in a very short time frame.
I agree we can’t count on the laws staying the same as they are now. I also agree with your bird-in-hand simple premise. That’s why I said “it could be beneficial …” The main point of the article deals with someone already getting insurance under Obamacare — bunch more income when you already blew the cliff so you can qualify the next year. Obamacare isn’t welfare. However, the simplest “fix” would be including Roth withdrawals in the definition for MAGI.
This is in interesting puzzle that has many more variables to the equation. I agree that we need to be careful about making long term plans based off current ACA legislation. However, I have to disagree that it is always a good idea to deffer the tax whenever possible. We are at some of the lowest historical tax rates in history. For many of our clients who retire prior to age 65, require very little income (because their homes are paid off) and they have large balances in tax deferred accounts; it makes sense to convert as much as they can to ROTH without pushing their taxable income above the 22-24% bracket. Otherwise, their RMD’s at age 70 will push them into a much higher tax bracket. The problem could even be worse if congress is forced to raise taxes to pay for all the deficit spending.