How Early Retirees Can Get Cheap Health Insurance

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.

Michael Yoder, CFP, CRPS is Principal at Yoder Wealth Management, which provides holistic financial advice for retirees and those transitioning into retirement.