Sunday, June 13, 2021

Help Clients Retire Early With the Affordable Care Act

Tax credits from the ACA can help bridge the coverage gap before enrolling in Medicare.

Scott Stratton
Scott Stratton

As an advisor, how can you help your clients realize their dream of an early retirement? Where can you add value beyond helping them grow their portfolio? The biggest obstacle to early retirement for many of your clients is the skyrocketing cost of health insurance. It’s such a huge expense that many assume they have no choice but to keep working until age 65 when they become eligible for Medicare.

However, if you can carefully plan their income sources, you may be able to help your clients qualify for a premium tax credit (PTC) and retire before age 65.

What’s the PTC?

A PTC is a tax credit for buying individual insurance on Healthcare.gov under the Affordable Care Act (“Obamacare”).  The key to planning for the PTC is to know what a client’s income levels are and what counts as income. Then, use other savings or income until the year after they reach age 65 and enroll in Medicare.

If you can bridge those years until 65, the PTC could cover a significant portion, or even all, of your client’s health insurance premiums. If your client knew they could get subsidized or even free health insurance, would that make it easier for them to retire today?

 The premium tax credit is available to people whose income is between 100% and 400% of the federal poverty level. For a single person, that means income between $12,760 and $51,040 for 2021. For a married couple, their combined income would need to be between $17,240 and $68,960. The lower the income, the larger their tax credit.

Please note that clients who are married filing separately are not eligible for the PTC. They must file a joint return. Federal poverty levels are indexed annually for inflation and are based on family size.

The PTC is calculated on your client’s estimate of their 2021 income and is paid in advance as a credit towards their insurance. If their actual income ends up being higher, they have to repay the difference. If their income is lower than estimated, they can claim the additional credit on their tax return. This is calculated for each tax year, on IRS Form 8962. For tax year 2020 only, the IRS has waived the repayment of any excess advance payment.

In March, the American Rescue Plan Act expanded the PTC above the 400% threshold so that no one has to pay more than 8.5% of their income for a benchmark plan. The Act also increased the amount of the tax credit for all levels. For example, a family with income of 100% to 200% of the federal poverty level now will pay 0% to2% of their income for a plan, versus 2.07% to 6.52% previously.

Unfortunately, this expansion is only funded for 2021 and 2022. Many in Congress see a need for this to become permanent. However, with a cost of $34 billion for two years, it’s unclear what will happen. The safest planning approach would be to assume your clients will need to be under 400% going forward. This will also net them a larger tax credit and will cover more of their insurance premium.

It’s worth noting that several states have programs for additional tax credits above the federal amounts.

ACA Income Calculation

Under the ACA, income is modified adjusted gross income (MAGI). Unfortunately, MAGI is not a line on the 1040 tax return. MAGI takes adjusted gross income and adds back items such as 100% of your Social Security benefits (which might have been 50% or 85% taxable), excluded foreign income, and even tax-free municipal bond interest.

Here is the full list of what’s included as income for the PTC from Healthcare.gov.

Examples of Monthly Benefits

The premium tax credit will reduce monthly insurance premiums. Here are some examples of the PTC, based on Dallas County, Texas, for non-tobacco users in 2021:

  • Single Male, age 63 with $45,000 income would be eligible for a PTC of $689 a month.
  • Single Male, age 63 with $25,000 income, PTC increases to $925 a month.
  • Married couple (male/female), age 63 with $60,000 income, would have a PTC of $1,567/month
  • Married couple (male/female), age 63 with $40,000 income, would have a PTC of $1,817/month.

Same sex couples are eligible for a Premium Tax Credit under the same rules. They must be legally married and file a joint tax return.

For this last example of a 63-year-old couple making $40,000, the government will subsidize the first $1,817 a month of their health insurance premiums. That means they could get a number of Bronze plans for free, or could get more coverage for a small monthly premium. The most expensive Gold plan would be $893/month after the PTC. Check rates and PTC estimates on Healthcare.gov.

Income Planning to Maximize the PTC

Here’s how you can minimize your client’s MAGI to maximize their premium tax credit so they can retire before 65:

  • Discourage them from applying for Social Security retirement benefits or a pension until at least the year after they turn 65. Imagine if starting $2,000 a month in Social Security income means losing an $1,800 tax credit!
  • Advise them not to take withdrawals from a Traditional IRA or 401(k). These distributions count as ordinary income.
  • They can, however, take distributions from a Roth IRA and that won’t count as income for the PTC. Just make sure they are age 59 ½ and have had a Roth open for at least five years. They can also access principal, but not earnings, before age 59 ½. If they are several years away from retirement, consider building up Roth balances with contributions, conversions or backdoor contributions.
  • Build up savings (i.e. “cash bucket”) to pay living expenses for the bridge years until age 65.
  • If your clients have investments with large capital gains, sell a year before they sign up for the ACA health plan. Avoid having those sales count as MAGI in the year they want a PTC.
  • In their taxable account, sell funds or bonds with low taxable gains in the years they will want the PTC. Or harvest losses. Limit rebalancing trades of appreciated positions to an IRA and avoid creating taxable gains.
  • Clients can pay for medical expenses or reimburse themselves from a Health Savings Account (HSA) for qualified medical expenses. Those are tax-free distributions.
  • If clients still have earned income when “retired,” a Traditional IRA (if deductible) or a 401(k) contribution will reduce MAGI. Don’t forget a Spousal IRA, if only one spouse is working.
  • The sale of a primary residence can exclude a capital gain of up to $250,000 single or $500,000 married. This is not counted towards MAGI for the ACA.
Minimum Income

An important point: The goal is not to reduce income to zero. If your client does not have income of at least 100% of the poverty level, they are ineligible for the PTC. Instead, they would be covered by Medicaid. That’s not necessarily bad, but to get a large tax credit and use a plan from the exchange, you need to have income of at least $12,760 (single) or $17,240 (married) for 2021.

“Health expenses are a big unknown for retirement planning. But your clients have options other than waiting until 65 for Medicare.”

Retire Early with the ACA

By delaying certain types of retirement income until after 65, your client may be eligible for a significant premium tax credit. This could amount to more than $20,000 a year. Even more importantly, you could help your client add years to their retirement and start early.

Due to COVID, there is a special enrollment period through August 15, 2021. So, clients could do this now, and not have to wait for the usual open enrollment period at the end of the year.

Any caveats? Consider, of course, that the plans on the exchange may have different deductibles, co-pays and networks than their current employer coverage. Have your clients to check if their existing doctors and medications will be covered in-network. Clients can understand the coverage better if they have an estimate of what they might pay out-of-pocket and are aware of what maximum annual costs would be.

Health expenses are a big unknown for retirement planning. But your clients have options other than waiting until 65 for Medicare. Educate them on the PTC, how it is calculated and what counts as income. Then, create a multi-year income plan that will help them qualify for the premium tax credit while still allowing them access to the funds they need.

Scott Stratton, CFPⓇ, CFA is the Managing Member of Good Life Wealth Management, a Registered Investment Advisor in Little Rock, AR. You can reach Scott at scott@goodlifewealth.com.

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