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.
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 at $18,000 per year in 2020 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 up to $16,168 a 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. Your income must be between 100% and 400% of the Federal Poverty Line (FPL) to qualify for the PTC. At these levels of the FPL, your cap is approximately 2% to 10% of income, respectively. This cap can be thought of as the expected contribution for health premiums.
The FPL varies based on household size. For David and Susan, a household size of two, the FPL is $16,910 in 2020, making 400% of the FPL $67,640. As long as their income is below $67,640, they will receive a PTC.
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 in 2019 was $1,376 per month for two 60-year-olds in 2019 or $16,506 per year. The PTC is then equal to the expected contribution less the SLCSP.**
For David and Susan at 400% of the FPL, the PTC is approximately $9,800 and would increase to more than $16,000 at 100% of the FPL!
Notably, the PTC remains the same regardless of whatever plan level (gold, silver, bronze) that David and Susan choose. For a bronze plan the PTC may fully offset the premiums.
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. If you go $1 over $67,460 in 2020, then your tax credit goes from $9,800 to $0. Triple ouch!
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 had cash in a trust account at the bank, the money can be spent without tax consequence and PTC will apply.
If you only have pre-tax money, you can still get creative. It may behoove you to utilize a low interest rate line of credit on your home, accumulate the balance and pay it off once on Medicare. Suppose you borrowed $100,000 and paid a 3% rate or $3,000 interest. However, doing so qualified you for a $16,000 PTC. Most would gladly pay $3,000 in interest to save $16,000 in a refundable tax credit.
Or perhaps you lump taxable income into one year to void the PTC but that allows you to attain it in subsequent years.
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.
** Note this is a 2019 benchmark where the premium cost for David and Susan is quoted on 2020 rates. For 2020 rates, the lowest cost bronze plan is about the same as the 2019 second lowest cost silver plan, indicating the benchmark plan for 2020 will be much higher.