Early retirees might
qualify for thousands of dollars of subsidies if they can keep their incomes
between certain limits.
by: Michael Yoder, CFP®, CRPS® June 19, 2017
If
you’re retiring before age 65, you’ll want to take a second look before turning
on any sources of taxable income, including pensions or IRA withdrawals. That’s
because you might jeopardize your ability to qualify for incredibly cheap
health insurance, as well as generous out-of-pocket cost subsidies.
I
have seen early retirees squander untold sums by not knowing about this, money
that could have been used to support their retirement.
Although
there is political uncertainty surrounding health insurance — including a legal challenge on cost-sharing
reductions by the House of Representatives that’s still up
in the air — the subsidies are slated to survive for at least a few more years
under the House plan, as I will explain below. In addition, with health care
reform stalling out, the likelihood is growing that the status quo will largely
prevail.
The Basics
Under
current law, when you sign up for health insurance on the exchanges (assuming
you make too much to be on Medicaid), you may qualify for two forms of
subsidies:
1.
A
tax credit on your health
insurance premiums if your household income is under 400% of the Federal
Poverty Level (FPL).
2.
Cost-Sharing
Reductions (CSRs) if your
household income is under 250% of the FPL, and you sign up for a Silver plan.
According
to 2017 HHS guidelines,
400% of the FPL is $64,960 for a married couple and $48,240 for singles,
however the figures are a little higher for residents of Alaska and Hawaii.
Even if you have a high level of assets, you’ll most likely have enough levers
at your disposal to keep your income under the limit. After all, you can choose
when to commence pension and Social Security benefits, when to trigger capital
gains, whether to take IRA withdrawals, etc. The more you’ve saved outside of
tax-deferred accounts, the easier this will be.
The Premium Tax Credit
The
premium tax credit applies to those whose incomes are between 100% and 400% of
the FPL, which would be from $12,060 to $48,240 for singles and $16,240 to
$64,960 for married couples. (Note: The lower boundary is 138% if you live in a
state that expanded Medicaid, because essentially you’d qualify for Medicaid
below that and therefore would not be eligible for subsidies.) This credit can
be applied against your premiums, reducing your monthly health insurance bill.
The
credits are targeted to keep your premiums below a certain percentage of your
income. For a couple at 150% of the FPL (which would be $24,360), for example,
a basic Silver plan would cost roughly 4% of their income. In dollar terms,
this works out to combined premiums of about $82 per month.
There
are a number of free online tools to help estimate your credits, including the
Kaiser Family Foundation calculator (available at http://www.kff.org/interactive/subsidy-calculator/).
Cost-Sharing Reductions (CSRs)
If
you can keep your income to between 100% and 250% of the FPL — which would be
from $12,060 to $30,015 for singles and from $16,240 to $40,600 for couples —
you can also qualify for reductions in your deductible, coinsurance and
out-of-pocket maximum, known as Cost-Sharing Reductions (CSRs). Again, just
like with premium tax credits, the lower boundary is 138% in states that
expanded Medicaid. But unlike the premium credits, which apply to all plans,
the CSRs apply only to Silver plans.
These
CSRs can amount to substantial savings annually. For example, a couple at 150%
of the FPL (or $24,360) could see their out-of-pocket maximum drop from $14,300
to $4,700. The reductions in deductibles and coinsurance vary by plan.
How to Make It Work
To
maximize your subsidies, if you are retiring before age 65, when Medicare kicks
in, evaluate whether you can defer any sources of income. In the meantime,
you’ll need to tap other assets, such as Roth IRAs or non-retirement accounts.
By
way of example, consider a 62-year-old couple with $35,000 of household income
(216% of the FPL). The husband just retired and can begin receiving a $30,000
pension. If he defers the pension to age 65, the benefit increases to $35,000
per year.
In
this case, he would be better off deferring the pension, since their current
income level allows them to qualify for the following subsidies (assuming they
live in an average cost area):
·
A credit of $16,982
toward their health insurance premiums each year until Medicare begins at age
65.
·
Cost-Sharing
Reductions (CSRs), if they choose a Silver plan, which could reduce their
out-of-pocket costs by thousands of dollars.
Had
the husband commenced his pension at age 62, he would have lost roughly $17,000
in premium credits, plus the CSRs. Including the taxes on the pension benefits,
turning on the pension at 62 would have cost them nearly as much as the pension
was worth!
From
age 62 to 65, the couple would need to tap non-taxable assets to cover their
living expenses. Upon reaching age 65, their coverage would switch to Medicare,
at which point they could safely turn on his (now increased) pension benefits.
Important Details
“Household
income” is defined as your Adjusted Gross Income plus municipal bond income,
untaxed Social Security benefits and foreign income. This means you won’t be
able to reduce includable income simply by moving your portfolio into tax-free
municipal bonds.
A
few other important points:
1.
The premium tax credit
is a rare example of a “cliff” benefit, where exceeding the limit by $1 would
cost you the entire credit. If your income is close to the 400% cutoff, be sure
to plan very carefully in order to avoid losing thousands of dollars in
subsidies.
2.
If your income is
below 100% of the FPL (138% in certain states), you will go on Medicaid, which
for many is not a desirable outcome because of potentially longer wait times
for patients and fewer participating doctors from which to choose.
3.
If you retire and have
COBRA or a retiree health plan available to you, you can still qualify for the
subsidies if you decline the coverage and buy your own instead (see the IRS website for details).
What About Health Care Reform?
Finally,
how will the American Health Care Act (H.R.
1628) affect all of this? First of all, it’s unknown how the
Senate’s version of the bill will look, but it appears they are treading more
cautiously than the House when it comes to rolling back benefits.
Even
if the House bill passes in its current form, the tax credits and Cost-Sharing
Reductions are available until 2020, although the tax credit in 2019 will be
slightly reduced for some people by up to 2% of their MAGI (see sections 131 and 202 of the Act).
You’ll
want to keep an eye on political developments, but for now it appears the
subsidies will exist for at least a few more years, and potentially longer. You
would be wise to plan accordingly.
Yoder
Wealth Management does not provide tax advice, and cannot vouch for or
guarantee the accuracy of third-party sites such as those linked in this
article.
This
article was written by and presents the views of our contributing adviser, not
the Kiplinger editorial staff. You can check adviser records with the SEC or
with FINRA.
About The Author Michael Yoder, CFP®, CRPS® Principal, Yoder Wealth Management
Michael
Yoder, CFP®, CRPS®, writes about issues affecting retirees and those
transitioning into retirement. He is Principal at Yoder Wealth Management (www.yoderwm.com),
a Registered Investment Advisor. 2033 N. Main St., Suite 1060, Walnut Creek, CA
94596. 925-691-5600.
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