Retiring Early and Paying for Health Insurance
As a financial advisor, I meet with individuals and couples who hope to retire early all the time - I mean, who doesn’t. Once I sit down with them for some basic number-crunching, we work together to create a long-term financial plan that will guide many of their decisions. 
This can include how much to invest, when and where to invest, and ways to increase cash flow and returns while keeping long-term costs and taxes to a minimum.
While most of my clients have similar fears about running out of money, there’s one single worry that pretty much everyone I encounter shares — how to pay for health insurance in the midst of wanting to retire early.
Every one of my clients will eventually qualify for Medicare at 65, but what happens until then? While the passage of the Patient Protection and Affordable Care Act, also known as Obamacare, made it so that anyone can get approved for health insurance regardless of pre-existing conditions, those major changes came with a dramatic cost.
According to a study by ehealthinsurance.com, average 2018 health insurance premiums worked out to $790 per month for individuals 55 to 64. Even individuals who fell into the 45-54 age group still paid an average of $541 per month for premiums only.
In other words, health insurance isn't cheap.
So, let’s take a look at a way where you might be able to qualify for healthcare subsidies (i.e. tax-credits) that might just save you thousands of dollars a year. You might just be surprised that you actually qualify or could at least make some adjustments that would allow you to qualify.
How to Qualify for Premium Subsidies in Early Retirement
Health insurance premiums can be a shock to the system when you’re hoping to retire prior to becoming eligible for Medicare. After all, it’s hard enough to build up a nest egg that can sustain your spending and inflation for 30 years or more.
On top of that, you now have to worry about saving enough money to pay for exorbitant health insurance premiums until age 65. And, these premiums don’t even take your annual deductible and other out-of-pocket healthcare expenses into account.
Interestingly enough, a quick look into the way health insurance premiums are set — and how premium subsidies are doled out —makes it easy to see how retirees could actually pay reduced premiums. You might ever be surprised at how reduced.
Some background: When the Affordable Healthcare Act was brought to fruition, its architects knew that covering everyone with health insurance regardless of pre-existing conditions would be an expensive affair. As a result, they built in premium subsidies and assistance with out-of-pocket healthcare expenses for Americans whose incomes were below a certain threshold.
To qualify for premium credits and other help, your household income must fall between 100% and 400% of the Federal Poverty Limit (FPL). Families below that should qualify for Medicaid, the theory goes, but families who earned above the 400% FPL threshold should be able to afford their health insurance premiums without any help - at least according to the government (some would argue, including myself).
Because health insurance plans and costs are highly variable depending on where you live around the United States, the amount of the premium credit you’ll receive will vary widely, but so will your health insurance premiums.
If you are able to keep your household’s modified adjusted gross income between 100% and 400% FPL during early retirement, you’ll most likely qualify for premium tax credits, and thus lower health insurance premiums.
How low does your income have to be to qualify for health insurance subsidies in early retirement? In 2020, a family of two qualifies for premium subsidies in most states when their modified adjusted gross income (MAGI) falls between 100% and 400% of the Federal Poverty Limit (FPL), or $17,240 to $68,690.
Qualifying for Health Insurance Premium Tax Credits: A Case Study
It’s not difficult to see an enormous difference in premiums if you’re able to reduce your modified adjusted gross income below 400% of the FPL, but here’s an example that shows how much a retired couple could save.
Imagine you’re two married early retirees living in Hamilton County, Indiana. You’ve done well for yourselves, and you have the retirement nest egg that’s large enough you can comfortably live on $70,000 per year.
Unfortunately, that’s more than 400% of the FPL, so you’ll face the full weight of health insurance premiums in Indiana at this income. According to this calculator from the Kaiser Family Foundation (KFF), the average cost for a Silver plan in your county and state works out to $1,470 per month.
Plus, with Silver plans through Healthcare.gov, you still pay 30% of healthcare costs and your plan pays 70% until your deductible and annual out-of-pocket maximum is reached. No matter how you cut it, that can be really expensive!
But imagine for a moment you were able to reconfigure the amount of money you live on by reducing your modified adjusted gross income. In that case, your entire healthcare scenario can be turned upside down.
For an early retired couple of the same age and in the same area with an income of $50,000 per year, average monthly health insurance premiums for a Silver plan drop to just $402 per month (total for both). And, if you could drop your taxable income even more to just $40,000 per year, your monthly premiums for a Silver plan drop to just $260 per month.
If you were somehow able to drop your taxable income to $28,000, your monthly premiums for a Silver plan would only be $113 per month! While that may seem crazy, there are strategies to reduce your income, especially if you have money/investments saved in taxable (non-retirement) accounts. We’ll talk more about this below.
Strategies to Lower Your Income In Early Retirement
While you may be able to change direction once you reach 65 and qualify for Medicare, finding ways to lower your taxable income in early retirement can definitely help you qualify for health insurance premiums you can actually afford.
Remember, the goal is getting your taxable income below the 400% FPL threshold, which varies depending on your family size. If you’re a family of two trying to enjoy early retirement with no dependents, however, that income threshold is $68,690.
When it comes to reducing income, keep in mind that your goal is reducing your taxable income, and specifically your modified adjusted gross income, or MAGI. Here are some strategies that can help you lower your MAGI, and thus qualify for some pretty lucrative health insurance premium tax credits. Also remember, many of these strategies can be used at the same time for even better results.
- Contribute to a Health Savings Account (HSA) (you do not need to be working or have earned income). If you have a high-deductible health insurance plan (which most Silver Plans are), you can contribute money to a HSA and lower your taxable income. In 2020, annual limits to HSAs are capped at $3,550 for individuals and $7,100 for families.
For your health insurance to qualify as an HDHP, your plan needs a minimum deductible of $1,400 for individuals and $2,800 for families, but it must also come with a maximum out-of-pocket amount below $6,900 for individuals and $13,800 for families.
- Contribute to a tax-deductible retirement account (only if you have earned income). If you are still working part-time, you could contribute to a retirement account like a 401(k) or make contributions to a traditional IRA. Either one will help to reduce your income.
Maximum contributions to any IRA are capped at $6,000 for 2020. However, you can contribute another $1,000 for a total of $7,000 in contributions if you’re 50 or older.
- Live off of non-IRA money i.e. a taxable savings/investment account. If you have money saved outside of your retirement specific accounts (IRA’s, 401(k)’s, 403(b)’s, etc.), then you could use this money to live off of until you’re eligible for Medicare.
When money is withdrawn from a taxable account, you typically only pay taxes on capital gains. These, most likely, will affect your modified adjusted gross income much less than if you were to make withdrawals from retirement specific accounts (which the entire amount would be taxed).
So, if you’re lucky enough to have saved money in a taxable account over the years, this is a great way to bridge the gap until 65 when you become eligible for Medicare. Then, once you are eligible for Medicare and no longer need the health insurance subsidies, you could start withdrawing money from your retirement accounts.
- Consider Roth IRA distributions until age 65. Maybe you begin taking distributions from a Roth IRA instead since those are typically tax-free. Note, that you can only take penalty-free distributions from a Roth IRA once you’re age 59 ½. However, you can withdraw your contributions (just not any earnings) from your account at any time prior. Distributions after 59.5 are typically, for the most part, 100% tax-free.
This is a little more complicated strategy and could have long-term consequences. I would encourage you to speak with your financial advisor or tax professional before considering withdrawing from your Roth IRA to keep your modified adjusted gross income low.
Other Considerations
If you are struggling to find ways to lower your income while still having access to enough cash to cover your expenses, you might also want to consider finding ways to spend less so you can leave more of your retirement nest egg alone. Since health insurance premiums can be exorbitant when you earn more than 400% FPL, having access to more money to spend won’t necessarily improve your lifestyle anyway.
Don’t believe me? Let’s take a look at the example couple we profiled above.
With $70,000 in taxable income each year, this couple faced $1,470 per month in health insurance premiums, which works out to $17,640 per year. When they lowered their income to $50,000 per year, however, their premiums for a Silver plan dropped to $402 per month, or $4,824 per year.
When you look at the net of each of these incomes minus insurance premiums (plus they’ll pay more in taxes on $70,000), you can see that most of the “extra” money the couple was bringing in went straight toward health insurance premiums.
$70,000 - $17,640 in health insurance premiums = $52,360
$50,000 - $4,824 = $45,176
This example underscores just how important it is to keep your taxable income down if you plan to retire early. If you don’t pay attention, small amounts of money could leave you paying higher health insurance premiums for no reason at all.
Pay attention to how much you spend, and try to live on less so you can qualify for subsidies that improve your bottom line. Healthcare is expensive regardless, but there’s no reason to spend more if you’re able to take advantage of the subsidies provided by the government.
If you have any questions at all, we are more than happy to help plan a strategy for you.
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