Many early retirees find they must utilize Affordable Care Act (ACA or Obamacare) policies to bridge the gap from employer-provided health insurance to Medicare at age 65. ACA policies are expensive but even affluent families may be able to obtain significant tax credits to offset premiums. These credits are now easier to obtain with with provisions in the American Rescue Plan (ARP) passed into law in March 2021.
Costs & Credits
Costs for ACA plans are based simply on age, location, and whether you use tobacco.
David and Susan, both 60-years old, live in Summit County 44333. Premium costs for a catastrophic bronze plan start around $15,000 per year and climb to more than $27,000 per year for a gold plan. Ouch!
And while you were paying for health insurance premiums pre-tax from your pay while working, now you are using after-tax dollars to pay for ACA premiums. Double ouch!
But the Premium Tax Credit (PTC) may help Dave and Susan save several thousand each year. The PTC is a refundable tax credit from the federal government that effectively caps what you pay for premiums as a percentage of income.
Before the ARP, your income must be below 400% of the Federal Poverty Line (FPL) to qualify for the PTC. This equates to approximately $70,000 for David and Susan. At this income level, their cap is approximately 10% of income or $7,000. This cap can be thought of as the expected contribution for health premiums.
The PTC also considers the cost of a benchmark plan, which is the second lowest cost silver plan (SLCSP) available in their location. The cost of this plan for two 60-year-olds is about $18,000 per year. The PTC is then equal to the SLCSP less the expected contribution. Thus for David and Susan, $18,000 SLCSP less $7,000 expected contribution yields a tax credit of $11,000.
Income for purpose of the PTC has its own definition. It is technically defined as your adjusted gross income plus certain items not subject to tax such as muni bond interest and any untaxed portion of Social Security. So be careful to include these.
You may think: I can’t keep my income that low. Well maybe you can even if you have substantial means. We have several retired clients with significant wealth that have availed themselves of significant PTC’s with tax-smart distribution planning.
Once retired you may have significant control over how you derive your retirement income and what shows on your tax return. Money may come from pre-tax IRAs/401ks, tax-free Roth IRAs, or assets like cash at the bank where you already paid tax.
If you live on $100,000, you may need to withdraw $115,000 from your 401k to net $100,000 after taxes, and this is fully taxable on your return. Thus you get $0 PTC. But if you have Roth accounts, after-tax cash or investments or even home equity, you may be able to craft your tax-smart distribution plan to claim the substantial credit.
Importantly, after the passage of the ARP for 2021 and 2022, the income limit has been removed and the caps are lower. We are now seeing many more clients able to qualify for several thousands in tax credits. Pending tax legislation is looking to extend these provisions but current law is the old income limits and caps will again apply in 2023.
The bottom line is healthcare is a primary concern for all. ACA premiums are expensive but significant tax credits are available, even to the affluent, provided you do yearly, tax-smart planning.