For early retirees who are not yet Medicare eligible, the cost of health insurance premiums can be as frightening as watching a scary movie in October.
According to a report published by eHealth, the average premium for an individual age 55 to 64 in 2020 was $784 per month and the average policy deductible was $4,364 per year.
Open enrollment for 2021 coverage through the Health Insurance Marketplace runs through Tuesday, Dec. 15, 2020, for coverage starting Jan. 1, 2021. With some creative income planning, early retirees can save money on their premiums and still meet their income needs.
Taking advantage of subsidies
When you enroll for health insurance coverage on the Marketplace, you’ll need to provide information about your household and expected income for the upcoming coverage year. If your stated income falls within 100% and 400% of the federal poverty level based on your household, then you will be eligible for “premium tax credits.”
These subsidies are effectively an advanced payment of premium that the government makes on your behalf to the insurance company during the year of coverage.
Household income is defined as modified adjusted gross income, plus most notably non-taxable Social Security benefits and tax-exempt interest. Eligibility for single households is capped at about $51,000 of stated income (about $69,000 for couples).
Your income determines eligibility for subsidies, not assets, so you can have substantial retirement assets and still be eligible for subsidies. The trick is ensuring your income remains below the threshold while still meeting your cash flow needs.
For example, assume Jack and Diane recently retired at the age of 62. They have a spending need of $100,000 per year to cover their lifestyle, fixed expenses and income taxes.
They own a home worth $500,000. They have 401(k)s with a combined total of $1,000,000 and Jack has a Roth IRA with $100,000. Diane inherited a $500,000 taxable investment account years ago with appreciated stocks and bonds that yield $12,500 per year of dividends and interest. They are eligible to apply for Social Security benefits of $40,000 per year now.
Let’s assume that Jack and Diane choose to meet their $100,000 spending need by filing for their Social Security benefits and then withdrawing $5,000 per month from their 401(k)s.
They receive $100,000 of cash income, but the reportable income for healthcare subsidies would be $112,500 ($60,000 of 401(k) distributions, $40,000 of Social Security benefits, and $12,500 of reinvested interest and dividends.)
They would not be eligible for any subsidies and their estimated premiums would be $2,072/month ($24,865 per year).
Delaying Social Security payments
Now, let’s assume that Jack and Diane choose to delay Social Security benefits for at least the upcoming year.
Instead, they distribute $40,000 from their 401(k)s. To cover the remaining $60,000 of need, they sell $50,000 of stock within Diane’s taxable investment account that results in a $10,000 capital gain and withdraw the proceeds. Lastly, they withdraw $10,000 from Jack’s Roth IRA.
They receive $100,000 of cash income, but the reportable income for healthcare subsidies would be $62,500 ($40,000 of 401(k) distributions, $22,500 of interest, dividends, and capital gains).
According to the Kaiser Family Foundation Health Insurance Marketplace Calculator, the second income strategy would yield $1,563 per month of premium tax credits, leaving Jack and Jill to pay $509 per month in health insurance premiums or 6% of their spendable income — compared to 25% of their spendable income under the first income plan.
Both plans yield $100,000 of spendable income, but the second plan saves them $18,752 per year in insurance premiums. That’s real money that could be spent on travel or a large purchase.
Some risk in this strategy
The strategy is not without its pitfalls.
Falling off the so-called “subsidy cliff” is the most extreme of them. If your actual income for the coverage year is greater than your stated income, you’ll be subject to a claw-back of a portion of the premium tax credits you receive. In some cases this could be 100% of the credits, which would result in a very scary tax surprise when you file your taxes for the coverage year.
In order to mitigate the risk of this happening, work with a Certified Financial Planner Professional and a CPA to run income projections during enrollment and throughout the coverage year to ensure a high probability of success.
Dan Mathews is a Certified Financial Planner Professional and a member of the Financial Planning Association of Greater Kansas City.