I’m not buying health insurance on the exchange under the Affordable Care Act (ACA) 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 ACA, 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. ACA 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.
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
[Photo credit: Flickr user **Mary**]