Even though the ACA has provided common standards, Health Insurance is still a complex topic with numerous trade-offs. Coverage levels and premiums vary. Every insurance company has a different approach to cost sharing. Each State has a slightly different implementation, maybe a different website, and wildly different prices.
Subsidies may pay nearly all of your premium, or they may cover nothing. It isn’t always clear which will apply until after the fact. As a result, some will get an extra large tax bill at the end of the year, while others will pay too much each month. They may even provide a disincentive to earn a higher income.
But much like the Income Tax, those who understand the the system can optimize their income and investments. Knowledge is power. Optimizing Obamacare starts with understanding the system. Then we can make choices to minimize costs and maximize coverage.
The Affordable Care Act Basics
Simply stated: the ACA requires everyone in the US to buy health insurance. Nobody can be denied coverage or charged more because of pre-existing conditions.
Policies are standardized in name and level of coverage: Bronze, Silver, Gold, Platinum. The only difference is how much you pay for health services versus how much the insurance company pays. The metal levels don’t indicate a level of quality or amount of care you can get.
A Bronze plan is expected to cover 60% of the total cost of care. This increases to 70%, 80%, and 90% for Silver, Gold, and Platinum plans, respectively. Premiums (prices) increase accordingly.
Each policy will be unique in how it covers the cost of care. One silver plan may have lower premiums but higher deductibles. Another silver plan may have a lower co-payment but a higher out of pocket maximum.
It is important to evaluate these differences against personal medical needs. As every kid who is forced to wear an over-sized Christmas sweater knows, bigger isn’t always better.
To ensure access to a quality level of coverage for everyone, subsidies (Premium Tax Credits) are provided. In practice, this means every household in America that qualifies for subsidies will pay the same price for a quality health plan as other households of the same size and income, irrespective of age, where they live, or level of health.
Premiums and Premium Tax Credits (aka Subsidies)
For a household that qualifies for Premium Tax Credits (PTC), only two pieces of information are required to determine maximum insurance prices for a Silver plan:
Households earning between 1-4x of the FPL qualify, which is the majority of households as seen by the high incomes in the table.
|FPL (2015) →|
Household size (↓)
Below 100% of the FPL (or 133% (or 138%) in some States) assistance programs such as Medicaid are (generally) available. (See brooklynguy’s comment for more.) Above 400% of the FPL, you don’t need subsidies for health insurance to be considered “affordable.” Congratulations.
Premium Tax Credits (PTC)
Premium Tax Credits (subsidies) are a direct function of household income.
The following chart shows an example for a 2 person household. The blue line shows the maximum cost for the Second Lowest Cost Silver Plan (SLCSP) available on the Marketplace, and comes directly from the IRS. In this example, the unsubsidized premium is ~$6k for my wife and me in Seattle, WA.
If income is exactly 100% of the FPL, the max we can pay is 2% of Income or ~$300/year. The PTC would fully cover the remaining ~$5,700. Thanks Obama!
If income is higher at 400% of the FPL, the max we pay is 9.5% of income or ~$5,950/year (~$500/month.) The PTC would cover the last $50.
If the SLCSP had a higher price tag (maybe $7k instead of $6k) the Premium Tax Credit would be larger. We would still pay the same fixed percentage of income, regardless.
But maybe we want a Silver plan with a lower deductible but a higher premium. Or we want a Gold or Platinum plan. In that case, we can apply our Premium Tax Credit to those other plans and we are responsible for any additional expense.
The method by which the Premium Tax Credit is reduced with income could be thought of as a tax. For each additional $1 of income, the PTC is reduced by $0.02, $0.15, or $0.095, or effective “tax” rates of 2%, 15%, and 9.5%.
Above 400% of FPL, the subsidy is eliminated completely. If the SLCSP is priced much higher than $6k, this can result in a very substantial increase in annual Premium. This is sometimes referred to as the Obamacare Premium Subsidy Cliff.
Obamacare Premium Subsidy Cliff
In the example above, earning more than 400% of the FPL wasn’t a big deal. The elimination of the PTC only causes our premium to rise by ~$50/year.
But the impact can be severe. To illustrate, I quoted ACA SLCSP prices for a few cities where we would consider having a home base.
Minnesota has some of the lowest insurance prices in the nation (Red line.) Even with the lower prices, our monthly premium is still the same as in the other states. We just receive a smaller subsidy.
Because of the lower cost of insurance, at ~300% of the FPL we would already be paying the full unsubsidized price. More income wouldn’t increase our costs. In Oregon (Green line) this same thing happens at ~350% of the FPL. But in California (Teal line) the annual price is an incredible $10k! If we earn more than 400% of the FPL, when the subsidy is eliminated our costs increase by ~$4,000!
And this could occur with even $1 of additional income.
That would be a rude wake-up call if we weren’t paying attention to our income throughout the year. In States with high cost of insurance, or if we choose a plan that costs much more than the SLCSP, it would be fiscally responsible to keep income below 400% of the FPL if at all possible.
This isn’t to say that it is all nice and easy in the other 3 locations. These quotes are based on our ages today. Barring some advances in anti-aging, the cost of insurance will rise as we age.
The following graph shows the lowest cost Bronze plan and the Second Lowest Cost Silver Plan for Seattle, WA for the two of us for ages from 30/25 to 60/55. Barring any change in the law, above Age 50 the danger of the cliff increases significantly. If premiums rise faster than inflation, it could be even worse. But as long as we stay below 400% of the FPL, our premiums stay roughly the same regardless of our ages. Subsidies just increase over time.
During the course of the year, the US Treasury transfers our expected PTC directly to the insurance company. Any discrepancies are taken care of when we file our taxes the following year. If these advance payments were too large, we would pay a little more on our tax bill.
If we fall off the Obamacare Subsidy Cliff, not only would we have to pay a massive increase in premiums ($4k in the California example), but we would also have to pay back all of those advance payments transferred to the insurance company.
In a totally different tone of voice this time, “Thanks Obama!”
Cost Sharing Subsidies
For households with income between 100% and 250% of the FPL, Silver tier plans come with additional Cost Sharing Reduction Subsidies (CSR subsidies.)
Normal Silver level plans are expected to cover about 70% of the total cost of care. With the CSR subsidies this is increased to as much as 94%, meaning deductibles, co-pays, and co-insurance will be reduced.
Most importantly, this shows up in reduced out of pocket limits. While this may be of limited value for households that don’t have a lot of medical needs, it can be the most valuable component of insurance for those that do.
Effectively, at incomes between 100% and 250% of the FPL, Silver plans can provide lower premiums and lower out of pocket maximums than even Gold or Platinum plans. Note that the out of pocket limits here are the legal limits; some plans could offer lower.
Optimizing Obamacare in Early Retirement
Obamacare optimization is essentially income optimization. Too little income, and you may end up on Medicaid or uncovered. Too much income, and you face a potentially serious subsidy cliff.
The maximum Premium Tax Credits and Cost Reduction Sharing Subsidies are available with incomes between 1-2x of the FPL. Even up to 2.5x is still a great deal.
Here is the 2015 FPL table again. Keeping income below $40-$50k (or even $60k for the unmarried couples out there) shouldn’t be terribly difficult for early retirees. It would certainly be easier than while working. Spending more is possible as well; cash, any basis in a brokerage account, and Roth IRA contribution withdrawals aren’t considered income for purposes of the MAGI.
|FPL (2015) →|
Household size (↓)
Of course, keeping income low for the sake of increased insurance subsidies might not be rational. It wouldn’t make sense to earn $100 fewer dollars to save $15 in insurance costs. But it may make perfect sense for households on the edge of the Subsidy Cliff or in years with high medical needs.
Being aware of income is critical!
Income Optimization Example
At 200% FPL we can get a Silver plan with 87% cost sharing for ~$200/month in Seattle, WA (and every other state) for all 3 of us. On this specific policy, out of pocket maximums are only $2.6k with deductibles of $500/person or $1,000/family. And it includes an HSA!
Using our 2014 tax return as a reference, there are challenges for us to stay below the 200% FPL threshold, even with the addition of a 3rd household member. Our choices are to earn less or take advantage of deductions.
Total MAGI in 2014 was $96,968 (Line 37 + Line 8b on our 1040), far surpassing even the 400% FPL threshold. (See how MAGI is calculated here.)
By contributing to the max allowed to an HSA, I can reduce our MAGI by $6,650 while also saving tax free for future medical expenses. Win-win.
The Business Income (Line 12) could be added to a Traditional IRA, reducing MAGI by another $1,987. Or the Self-employment health insurance deduction (Line 29) would allow me to deduct the monthly premiums, which would also eliminate the full amount of Business Income.
At this point, I would also need to eliminate the $46,725 of Capital Gain income. This was optional income generated by Harvesting Capital Gains at the 0% tax rate, part of our plan to never pay taxes again. By harvesting $3k of capital losses instead (the maximum offset), our MAGI would be reduced by a total of $49,725.
This now brings our MAGI to $38,606, a couple thousand dollars below the 200% FPL level. We now have great heath insurance at a very reasonable price.
In all likelihood, an early retiree in the United States is going to purchase ACA (Obamacare) compliant Health Insurance on the Federal or a State Health Insurance Marketplace. Guaranteed access to insurance can help many cut the employment handcuffs.
The Premium Tax Credits are a direct function of income, ensuring families of a same size and income have the same cost of insurance, regardless of age, where they live, or health care needs. Just stay below that 400% of FPL subsidy cut-off. By optimizing our level of income we can maximize our health insurance benefits.
Tracking income is critical to ensuring that at a minimum we don’t hit the Subsidy Cliff, which can have severe financial repercussions. If you aren’t currently tracking income from all sources, Personal Capital is a great free tool for doing just that, automatically.
It is possible to maximize benefits by keeping MAGI between 1-2.5x FPL and choosing a Silver plan. There are obvious trade-offs between income optimization now vs future tax savings from Harvesting Capital Gains and Roth IRA Conversions. This will be explored in a future post (Coming soon: this post was originally research for that larger topic)