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Early Retirement Health Insurance: What You Should Know

Affordable health insurance is one of the biggest obstacles preventing people from early retirement. The health insurance gap from retirement to Medicare starting at age 65 can be expensive for those who do not have retiree health insurance provided to them by a former employer. The reason health insurance is frequently expensive for many people has less to do with the health insurance and more to do with poor planning.

Planning Ahead

This lack of planning can oftentimes lead to expensive health insurance because many people who retire before age 65 use Affordable Care Act insurance before Medicare starts. Affordable Care Act insurance goes by a few different names, including Obamacare and ACA insurance. Presently 30 states have ACA insurance available, while 20 states and the District of Columbia have state-run health insurance programs. The cost you will pay for ACA insurance and state-run health insurance programs can be heavily influenced by your household’s modified adjusted gross income (MAGI). The higher your household’s MAGI, the greater the cost of your health insurance. For simplicity’s sake, the remainder of this article will focus on strategies designed to reduce ACA insurance costs for retirees younger than 65. These strategies are generally applicable to the 15 states with state-run health insurance as these states provide lower-cost health insurance based on income level.

The reason ACA insurance costs increase as MAGI increases can be attributed to tax credits. Tax credits are the government’s way of providing lower-cost insurance to people with lower incomes. The lower your MAGI, the greater the amount of tax credits you receive, and these tax credits can be used to offset the cost of your ACA health insurance in retirement. Fortunately, many strategies can be used to reduce your MAGI without compromising your spendable income in retirement. Unfortunately, many people delay this type of planning until after retirement, which significantly reduces the benefits.

To understand how to decrease your ACA insurance costs without compromising your spendable income before age 65, it is essential to understand what counts as MAGI and what does not count. The following is a partial list of income streams that count and do not count toward modified adjusted gross income:

What Counts (ACA Unfriendly)   

  • Social Security income.
  • Pension income.
  • Wages/salary/business income.
  • Distributions from traditional individual retirement accounts (IRAs), and 401(k) and 403(b) plans.
  • Gains from appreciated investments.
  • Dividends and interest income.

What Does Not Count (ACA Friendly)

  • Qualified distributions from Roth IRAs, Roth 401(k)s, and Roth 403(b)s.
  • Distributions from bank accounts: checking, savings, and money market.
  • Distributions of basis from appreciated investments.

Social Security, pensions, and traditional IRA distributions all count toward MAGI increasing your ACA health insurance cost in retirement. I call these income streams “ACA unfriendly.” Qualified distributions from Roth accounts, bank accounts, and the basis of appreciated investments do not count as MAGI. I call these investments “ACA friendly.”

Now that you understand some basic principles behind various income streams, you can develop your strategy using a three-step approach.

Step 1

First, determine the cost of ACA insurance at various income levels by going to healthcare.gov or talking with a health insurance agent who focuses on ACA insurance. The cost of purchasing ACA insurance through an agent is typically the same as buying it yourself through healthcare.gov. The benefits of using a knowledgeable agent can include simplicity, knowledge and service that you will not receive if you attempt to do this on your own.

Step 2

Once you understand your ACA costs at various income levels, it is essential to determine how much income you will need to live comfortably before Medicare.

Step 3

Once you have determined your income needs, it is important to develop a plan to provide you with the lifestyle you desire while minimizing your ACA insurance costs by controlling your MAGI. Achieving this goal may entail increasing contributions to the ACA-friendly investments that will provide income that does not count toward MAGI. Another consideration may include delaying Social Security and pension income until after you start Medicare, as these income sources count toward MAGI. IRA conversions to Roth IRAs in advance of retirement can also make sense in certain situations. Ultimately, it is important to ensure you are allocating enough money to the ACA-friendly investments so they will provide you with ample income before you are eligible for Medicare at 65. Ensuring you have the appropriate amounts in the ACA-friendly investments can take time, which is why I encourage people to consider this well in advance of retirement.

In Summary

There are a variety of different ways to create a retirement strategy that will provide you with affordable health insurance prior to Medicare without having to compromise your spendable income in retirement. To achieve this goal, it is important to take an inventory of what you will need for spendable income and compare it to your available future income sources. This practice will help you determine the types of investments to allocate your retirement funds. Considering the implications of the kind of investments you are contributing to in advance of retirement can provide you with the time needed to develop the appropriate amounts required to maintain your lifestyle while minimizing unnecessary ACA insurance costs.

Originally posted in Forbes July 29, 2021

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