Now that I left my job, I’m buying health insurance on the exchange under the Affordable Care Act (ACA). Before ACA, getting health care coverage is one of the biggest challenges for becoming self-employed. Forget about the cost; just getting a policy is a challenge by itself. ACA changed all that. Now self-employed people 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 Federal Poverty Levels (FPL) For Affordable Care Act for where 400% FPL is at for your household size.
Your MAGI for the purpose of ACA is basically:
- your gross income;
- minus pre-tax deductions from paychecks (401k, FSA, …)
- minus above-the-line deductions, for example:
- pre-tax traditional IRA contributions
- HSA contributions
- 1/2 of self-employment tax
- pre-tax contribution to SEP-IRA, solo 401k, or other retirement plans
- self-employed health insurance deduction
- student loan interest deduction
- plus tax-exempt muni bond interest;
- plus untaxed Social Security benefits
Wages, interest, dividends, capital gains, pension, withdrawals from pre-tax 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 household 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. If you can manage it, you definitely want to keep your 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 those who rely on an investment portfolio for income.
When you are 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.
When you supplement your income with part-time self-employment, you still have the option to contribute to pre-tax traditional 401k, IRA, and HSA. Those pre-tax contributions lower your MAGI, which helps you stay under the 400% FPL cliff when necessary.
This also means that, for those who need to buy health insurance on the ACA exchange, 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 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 health 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 401k or IRA to Roth. That’ll raise your income. Just remember to do it before December 31.
Please read these related articles in the series about the Affordable Care Act:
- Marriage Penalty Under Obamacare ACA Premium Subsidy
- Income Bunching 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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