Since the passing of the new tax law effective in 2018, major tax software vendors such as TurboTax, H&R Block, and TaxACT updated their online tax calculators.
These tax calculators do an adequate job for the most part. However, none of them includes the premium tax credit when you get health insurance under the Affordable Care Act (ACA), also known as Obamacare. To millions of people who get subsidy for health insurance from the ACA, this is a major gap, because their income affects the amount of subsidy they will receive. Getting more subsidy reduces their tax dollar for dollar; qualifying for less subsidy increases their tax dollar for dollar.
The most accurate way to project taxes is to use the downloaded/installed tax software. However, tax software for the current year won’t be available until November or December. I found a link to a spreadsheet posted to the Bogleheads Wiki. It’s called Personal Finance Toolbox. It’s an actual spreadsheet file, not an online one. You will need Microsoft Excel or compatible software to open it. As with anything downloaded from the Internet, you will have to trust the source. With 13 tabs, this spreadsheet does a lot of things. It looks overwhelming if you are only looking for one feature out of many.
I will show you how this spreadsheet can help calculate the effect of Roth conversion or long-term capital gains when you receive subsidy for health insurance from ACA. I used version 11.13 released on July 20, 2018. I don’t know the author of this spreadsheet. Nor did I verify its accuracy. I assume it’s reasonably accurate because it looks like the author put a lot of work into it.
Two adults, both age 60, retired, married filing jointly, no dependents. They live on $40k traditional IRA withdrawals and $5k qualified dividends. They have no other income or deductions. The full price of the second lowest cost Silver plan from the ACA marketplace is $2,000/month. They chose that plan, paying $250/month out of pocket, with $1,750/month from the advance subsidy. Questions:
- How does it affect their taxes if they convert additional $10,000 from their traditional IRA to Roth?
- How does it affect their taxes if they realize $10,000 in long-term capital gains?
Personal Finance Toolbox
We go to the Calculations tab. First we enter their filing status, number of dependents, and ages starting at cell G2.
Next we enter their income. Because they are retired, we skip the paycheck items and we go down to non-paycheck income starting at cell D23. We only input into cells in green. Use annual numbers here.
Then we go down to the monthly average expense section and enter the full price health insurance premium and the advance subsidy in cells B113 and B114. Remember to enter the monthly numbers here. Enter the advance subsidy amount as a negative number.
Now scroll to the far right to cell AC87 or use the find function in your spreadsheet software to locate “Form 8962.” Enter the full price of the second lowest cost Silver plan in cell AE99. Use the annual number here. You may notice it shows “Other 48” in this area. If you live in Alaska or Hawaii, enter “AK” or “HI” in cell H35.
Finally, we go back to the tax calculation area starting at cell F11. This shows their baseline estimated federal income tax.
As you see from above, the spreadsheet estimates that this retired couple will pay $2,552 in federal income tax. With $45,000 in AGI, that’s average tax rate under 6%. Normally they would be good candidates for converting a part of their traditional IRA to Roth to take advantage of their low tax rate before they start Social Security and before RMDs start.
What happens if they convert $10,000 from traditional IRA to Roth? We go to the non-paycheck income section and change cell D31 for “tIRA distribution” from $40,000 to $50,000.
Now we go back to the tax calculation area starting at cell F11. The estimated total federal income tax changes from $2,552 in the baseline to $4,997.
$4,997 – $2,552 = $2,445. This means they will pay additional $2,445 in federal income tax when they convert $10,000 to Roth. That’s 24.5% marginal tax rate (higher if the state also taxes the conversion). Due to the loss in health insurance subsidy, the Roth conversion is effectively taxed twice as high as otherwise.
Long-Term Capital Gains
What happens if instead of converting $10,000 to Roth they realize $10,000 in long-term capital gains? We go to the non-paycheck income section, change cell D31 for “tIRA distribution” back to $40,000, and we enter $10,000 in cell D27 for “Long-term capital gains (LTCG).”
Now we go back to the tax calculation area starting at cell F11. The estimated total federal income tax changes from $2,552 in the baseline to $3,858.
$3,858 – $2,552 = $1,306. This means they will pay additional $1,306 in federal income tax, or a 13% marginal tax rate when they realize $10,000 long-term capital gains. Long-term capital gains are normally taxed at 0% at their income level. The tax increase in this scenario comes 100% from qualifying for a lower ACA health insurance subsidy. The marginal tax rate is higher still if you add state income tax on the capital gains.
This exercise shows that converting to Roth or realizing long-term capital gains while receiving the health insurance subsidy from ACA will incur higher federal income tax than if you are not receiving the health insurance subsidy. The Personal Finance Toolbox spreadsheet does a good job in calculating the effect. It isn’t the easiest to use when you have to go all over the place to find the right spot for your inputs and look at the results. However, it works once you know where to enter things and what to look for. It includes the effect on ACA subsidy when tax calculators from major tax software vendors don’t. I thank its author for making this tool available.
Say No To Management Fees
If you are paying an advisor a percentage of your assets, you are paying 5-10x too much. Learn how to find an independent advisor, pay for advice, and only the advice.