One of the challenges of an early retirement includes the need to budget for increased health insurance expenses prior to the onset of Medicare at age 65. During our working years, health insurance is typically provided at no cost by our employer or at a significantly reduced cost with employer assistance. A failure to appropriately account and plan for health insurance costs in retirement can derail a plan and create unpleasant surprises.

Those who retire prior to age 65 and without any retiree insurance typically rely on the government health insurance exchange to purchase coverage. The average cost of this coverage far exceeds what retirees were typically used to during their working years. These costs are also very specific to each state and county, so be sure to use the tools referenced below to closely examine all relevant costs based on where you’re located.

For example, let’s look at a married couple living in Arlington, Virginia with the following characteristics:

• Husband (age 62) and wife (age 60)
• Reside in Arlington County, VA (ZIP code 22201)
• Report $80,000/year of income in retirement (a small pension and taxable investment income comprised of dividends, interest, and capital gains)
• Not smokers, no dependents, and not currently eligible for health insurance through Medicaid, Medicare, or their prior employer

Using the health insurance cost calculator on the health exchange website we determined that for a middle-of-the-road plan (Gold rated) the estimated monthly premium is approximately $2,200 (or $26,400/year).

The bad news? These premiums represent a significant retirement expense and are likely to rise each year going forward. The good news? With the right advisor and financial plan, you can offset these premium costs by taking advantage of health insurance tax credits offered as part of the Affordable Care Act (ACA).

Let’s look at how these tax credits work:

1. Unlike other government programs, the ACA’s requirements and definitions for health insurance premium tax credits are based on your income, not wealth or assets. A retiree with a $5 million portfolio is treated no differently than a retiree with a $100,000 portfolio.
2. The formula to determine subsidy amounts are a function of age, reported income, and the health insurance costs in your county. These amounts vary widely based on geographic location, but the general theme is the higher the costs of insurance the greater the available subsidies.
3. The definition for income used is your modified adjusted gross income (MAGI).  To qualify for a 2019 premium subsidy, your MAGI cannot exceed:
   1. $48,560 if you’re single and
   2. $65,840 if you’re married (or have an eligible child in your household)
4. Examples of income sources that are fully INCLUDED toward your MAGI calculation:
   1. Wages (if still working in retirement)
   2. Self-employment income
   3. Pension income
   4. Dividends and interest (including municipal bond interest!)
   5. Capital gains realized in your taxable accounts
   6. Withdrawals from retirement plans (traditional IRAs, 401(k),403(b), and 457 plans are a few examples)
   7. Annuity withdrawals (depending on tax treatment and cost basis)
5. Income sources that are fully EXCLUDED from your MAGI calculation include: 
   1. Withdrawals from cash accounts and CD’s (that aren’t traditional IRAs)
   2. Withdrawals from Roth 401(k)s and Roth IRAs
   3. Capital losses realized in your taxable investment accounts
6. You also need to make between 100 and 400 percent of the federal poverty level to qualify for the premium insurance subsidy. Information on the federal poverty level can be found here: https://aspe.hhs.gov/poverty-guidelines. As an example, you’ll qualify for the health insurance subsidy as an individual with an income range of
   1. $12,140 to $48,560 for a single individual (the lower threshold is $16,874 if you’re in a state that has expanded Medicaid)
   2. $16,460 to $65,840 for a couple (the lower threshold is $22,879 if you’re in a state that has expanded Medicaid.

One positive is that in retirement, your reported income (and thus, your MAGI) can be managed by considering the following:

1. Does it make sense to continue working if the additional income precludes me from earning health insurance subsidies?
2. Is my portfolio tax efficient? Holding the wrong types of assets in the wrong accounts, realizing unnecessary taxable gains, and failing to offset capital gains with capital losses are all examples of inefficiencies that can push your plan off track.
3. Do I have the right income distribution plan? Everyone has a retirement budget but not everyone has a plan for which account they will draw the necessary funds from and when. A few changes to your distribution plan can make a significant difference when it comes to qualifying for these subsidies. Beware of typical rules of thumb, such as drawing funds from your taxable accounts first before tapping into retirement plan funds. Everyone’s situation is unique.

Now, let’s go back to our previous example assuming the couple revised their financial plan to be more tax-efficient, thus reducing their reportable income:

• Husband (age 62) and wife (age 60)
• Reside in Arlington County, VA (ZIP code 22201)
• Report $50,000/year in income (small pension and more tax-efficient portfolio income)
• Not smokers, no dependents, and not currently eligible for health insurance through Medicaid, Medicare, or their employer

Using the health insurance cost calculator on the health exchange we now determine that the couple qualifies for a monthly premium tax credit of $1,800/month for potential annual savings of $21,600.

When it comes to planning for health insurance costs, a retiree must develop a structured plan to generate the necessary funds for living expenses while NOT generating income over certain thresholds. In the case of the ACA insurance subsidies, if your income is too high–even by $1–you get nothing. That’s a big risk and emphasizes the need for careful planning.

Hopefully this explanation provided valuable insight. Please consult with our team if you have any follow-up questions regarding retirement strategies.