Bob and Patricia are 60 years old and would love to retire as soon as possible. It’s not uncommon to meet people like Bob and Patricia who have been saving diligently, setting money aside into their 401(k)s, making wise investments, and living below their means with a desire to transition into retirement as early as possible. Unfortunately, health insurance for them to retire before age 65 can now cost as much as $2,000 per month for a high deductible health insurance plan, even for someone who has significant savings, this additional expense can make early retirement unaffordable.
In the past, many people were able to leave the workforce and continue to receive health insurance through a former employer. These retiree health insurance plans would bridge the gap between the time that someone left the workforce and the time they began receiving Medicare benefits at age 65. Unfortunately, most of these benefits, along with other retirement benefits like generous pensions, have gone the way of the Dodo bird. If you are one of the few that still have these benefits available to you, count yourself very fortunate. So, is there a way to retire before age 65, and purchase affordable health insurance? The answer is yes! But it requires special planning.
The Affordable Care Act
The Affordable Care Act, also commonly known as, “Obamacare” contains a provision that provides health insurance subsidies to Americans below certain income levels. To qualify for a health insurance subsidy or discount, your household income cannot be more than four times the federal poverty line. The federal poverty line is based on the number of people in your household. Looking at Table 1., four times the federal poverty line ranges from $49,960 in 2020 for a household of one, all the way up to $138,360 for a household of six. Since Bob and Patricia have a household of two, they would need to have an income below $67,640 in 2020 to qualify for a subsidy, and the subsidies are significant.
|Table 1. FEDERAL POVERTY GUIDELINES (YEAR 2020)|
|# In Household||Federal Poverty Line (FPL)||2-Times (FPL)||3-Times (FPL)||4-Times (FPL)|
For example, Bob and Patricia, Utah residents, would receive $1,345.29 per month if they reported an income of $65,000 for the year. If Bob and Patricia were to choose a high deductible Bronze plan (See Table 2.) that would typically cost about $1,227 a month. Applying their subsidy of $1,345.29, they wouldn’t have to pay a monthly premium. Now let’s say they select a gold plan that costs $2,403 per month; they would only have to pay $1,058 after their subsidy is applied. That’s a savings of over $16,000 a year in healthcare expenses.
|Table 2. EXAMPLES OF HEALTH INSURANCE PLANS AND IMPACT OF SUBSIDIES|
|Plan||Bronze Plan||Silver Plan||Gold Plan|
|Quotes ran August 2020 at www.healthcare.gov. Based on a household of two with an annual modified adjusted gross income of $65,000|
You might be thinking, this sounds great, but I’m not sure I’m willing to restrict myself to only living on an amount that’s below the threshold to qualify for these discounts.
Well, here’s where the planning comes in. The discounts are based on your modified adjusted gross income (MAGI). We need to be careful not to confuse this with cash flow coming into the household.
Modified Adjusted Gross Income (MAGI)
Let’s look at how the tax code defines modified adjusted gross income for health insurance – to determine your modified adjusted gross income, the tax code looks at your adjusted gross income (AGI) and adds back in a few income sources that are normally not included. Three of the most common income sources that must be added back into AGI to come to the MAGI calculation are:
- Excluded foreign income
- The Non-taxable portion of Social Security
- Tax-exempt interest
Once MAGI is calculated, there are ways to keep your income below the 400% of the federal poverty line income limit that would allow you to qualify for subsidies and still have the monthly cash flow you would like.
Let’s return to the case of Bob and Patricia and see how this would work. Let’s say that Bob and Patricia have saved $3,000,000 for retirement. These savings include pre-tax accounts like 401(k)s and IRAs, tax-free accounts like Roth IRAs, and after-tax brokerage investment accounts. Bob and Patricia decide that they would like to have $100,000 per year in income. Bob and Patricia can control how much of their $100,000 income are included in their AGI by choosing which accounts they take distributions from.
Example: Bob and Patricia decide to take out $50,000 from Bob’s IRA over the year for income. They then supplement their IRA income by taking out $50,000 from Bob’s after-tax brokerage investment account. Bob is careful not to sell stocks that have embedded capital gains, which would be added to their MAGI. This means that Bob and Patricia will be able to enjoy $100,000 per year of income but only report about $50,000 on their taxes. This would allow them to then qualify for the significant health insurance subsidies.
This example doesn’t consider things like capital gains, interest, or dividend income that would likely be applicable in their case. These items need to be considered, so careful planning is required. However, the point remains that this strategy would allow someone to enjoy the amount of income they prefer, while simultaneously qualifying for significant subsidies for health insurance.
One last note on health insurance subsidies for early retirees. When you apply for health insurance during open enrollment, you will have to estimate your income or MAGI for the following year. For Bob and Patricia, this means that they would state their income on the application as $50,000 using the numbers from the example above. You might ask, what if my income ends up being different from my estimate? Any difference in income between your estimate and actual income will be reconciled when you file your taxes for the following year. If your actual income is higher than the estimate you used on your application, you would be required to pay back a portion of the subsidy you received. If your actual income is lower than your estimate, you may be eligible for a higher subsidy, which would be paid to you as a tax credit.
In my experience, this isn’t much of an issue unless your actual income is so high that you wouldn’t have qualified for a subsidy at all. In this case, you would be required to pay back the entire subsidy you received throughout the year. In Bob and Patricia’s case, this would mean coming out of pocket $16,000 to pay back the subsidies they received based on their income estimates.
Careful planning is the key. If you understand and follow the rules you can receive significant benefits, if you mess up, you’ll go from thinking you’ve saved money to having to pay out large sums at tax time.
There are other aspects of this planning strategy for early retirees that I haven’t mentioned in this article, but this is a good start. I would recommend you consult with a qualified financial professional that is knowledgeable in the detailed tax rules associated with the Affordable Care Act before attempting to implement this strategy. If you’ve prepared well, early retirement is an achievable goal. Health insurance is a significant expense, that can derail your ability to retire early. However, there are powerful planning strategies available to the well informed to help you retire with confidence.
Mark P. Whitaker, MS, CFP®, CRPC® is a financial advisor and partner with Peterson Wealth Advisors, an SEC-registered investment advisor practice located in Utah. Peterson Wealth Advisors specialize in helping successful professionals transition into retirement and helping clients through retirement by providing expert investment and financial planning advice. Peterson Wealth Advisors are the only retirement specialists who offer the Perennial Income Model™, a proprietary investment approach that matches a retiree’s investments with their current and future income needs. Mark holds a bachelor’s degree in Personal Financial Planning from Utah Valley University and a master’s degree in Financial Planning from The College for Financial Planning. Mark is a Certified Financial Planner™ professional and holds various other industry-recognized certifications. Mark loves his country; he served for 11 years in the Utah Army National Guard, including a deployment to Afghanistan. Mark loves his family and lives with his wife and children in Provo, Utah.