How to Save Over $20,000 Per Year on Health Insurance When You Retire

Full transcript with subheadings:

Failing to properly plan for health insurance before 65 is consistently one of the more preventable, costly mistakes I see people make.

So today we’re going to talk about how to save potentially over $20,000 per year on health insurance when you retire.

Health Insurance Options Before Medicare

If you retire before the age of 65 and you don’t have health insurance provided to you from a previous employer, many people will either go on COBRA health insurance, which is temporary health insurance to get them to age 65, or to get them a portion of the way to age 65 when Medicare kicks in.

But we find a more affordable option that can be permanent until age 65 is Affordable Care Act insurance, and you might live in a state which has a state-sponsored version of Affordable Care Act insurance.

Affordable Care Act insurance is a popular strategy that can be very cost inexpensive for certain people, especially if you plan properly in advance.

And we’re going to be talking about that much more thoroughly today.

Factors That Affect ACA Insurance Costs

So factors that can affect your insurance cost, especially if you’re on Affordable Care Act insurance—and we’re not going to be talking about COBRA beyond this point—because we’re just going to really delve into how to make Affordable Care Act insurance affordable, or a state-sponsored version of Affordable Care Act insurance.

Most of these insurances that you’ll purchase to get you from retirement to age 65 when Medicare kicks in are affected by things like your age, your location, the number of people that are covered, your history of tobacco use, the plan you choose, and tax credit availability.

And tax credit availability, from what I’ve seen, is typically one of the factors that will affect the cost of this type of insurance the most.

And for that reason, that’s what we’re going to focus on from this point forward.

Understanding Modified Adjusted Gross Income (MAGI)

So the way that tax credits work with Affordable Care Act insurance or a state-sponsored version of Affordable Care Act insurance is it’s based on modified adjusted gross income. So as your modified adjusted gross income goes up, your cost of health insurance typically goes up because you get fewer tax credits to offset the cost of your health insurance.

Now, to understand modified adjusted gross income and how it’s calculated, it’s imperative to understand how different retirement investments are treated.

And so that’s what we’re going to go over next, because a lot of the strategies are highly dependent on how you organize your different—your three different investment tax buckets.

The Three Investment Buckets

Tax Deferred Bucket

Let’s just say for simplicity that all of your different investments that you have for retirement have to fit into three different buckets: the tax deferred bucket, the tax free bucket, and the non-qualified bucket.

The tax deferred bucket could include things like IRAs, 401(k)s, 403(b) plans, 457(b) plans. All of these work pretty similarly from the perspective that when you put money into this bucket, the money goes in on a pretax or tax deductible basis, and the money grows on a tax deferred basis. However, when you take money out of this bucket in retirement for qualified reasons as income in the year you take it out, you’re going to pay tax on those distributions.

And generally, it’s fully subject to tax. And generally, it’s fully subject to modified adjusted gross income, which can increase the cost of your health insurance.

Tax Free Bucket

When you contrast that to the tax free bucket, which would include things like Roth IRAs, Roth 401(k)s, Roth 403(b)s, Roth 457(b) plans. Many, many of you probably don’t have all of those, but you might have one or a few of these different types of tax free investments.

When you put money into this bucket, the money doesn’t generally get some sort of big tax advantage up front. However, the money will grow tax free, and if it’s taken out for qualified reasons in retirement, it comes out income tax free and does not count towards modified adjusted gross income.

Non-Qualified Bucket

Now, with non-qualified investments, it works a little bit differently depending on the type of investment that you own in this bucket.

And we’re going to talk about a few different types of investments here in just a little bit.

If you own a bank account like a CD or a money market account or savings or checking account—if you put $100,000 into one of those investments, let’s just say a money market for simplicity—the $100,000 you invest in is called your basis.

You can always take that basis back out of your money market account, and it’s not subject to taxation. However, the interest that you earn on an annual basis is subject to taxation and does count towards modified adjusted gross income. Similarly, if you own a corporate bond or a government bond and invest $100,000 into either one of those, that’s your basis and you can always take that basis back out income tax free. However, the interest that you earn on those government bonds and corporate bonds, those are subject to taxation and do count towards modified adjusted gross income.

Now, if you own stocks, stocks work a little bit differently. If you invest $100,000 into a stock, again, that stock, that $100,000, that’s your basis. And you can always take the basis back out income tax free.

However, the dividends that you earn are taxed on an annual basis. And if you have appreciation in your stock and you later sell that stock, you’re going to have gains and you’ll have to pay something called capital gains tax tax rates, which also can affect your modified adjusted gross income.

Now, if you own mutual funds in this non-qualified bucket, you have to be very careful with the type of mutual funds that you own, whether they’re stock mutual funds or bond mutual funds, and how actively those mutual funds are being managed. Because within a stock mutual fund, for example, if the mutual fund manager is consistently buying and selling stocks within the mutual funds, which is creating gains, those gains are subject to tax, as are the dividends of the stocks owned within the mutual fund.

In some of these, mutual funds can be highly tax inefficient to own in that non-qualified bucket when owned. And the other buckets like the tax deferred or tax free bucket, this doesn’t apply. This only applies to when you own actively managed mutual funds in that non-qualified bucket.

Now there’s a company called Morningstar that measures something called tax cost ratio, which can give you an idea on how tax efficient or inefficient a mutual fund is.

A real efficient tax mutual fund to own in the non-qualified bucket would have a tax cost ratio of 0.3 per year. A really heavily taxed mutual fund and this would be extreme would have a tax cost ratio of 5.

So essentially if you had a 1% tax cost ratio when your mutual fund went up 10% after taxes, what you get to keep would be more like 9, because you’d subtract the 1% per year and tax cost ratio from the return of the mutual fund.

And so not only does that detract from your returns, but that tax cost adds to your modified adjusted gross income, which detracts from your tax credits. So you have to be very careful with the types of mutual funds that you own in this market, especially if you’re in a situation where you’re going to need Affordable Care Act insurance to cover you from retirement to 65 when Medicare kicks in.

What Counts Toward MAGI — and What Doesn’t

I think it’s imperative to understand all of the different things that are included in modified adjusted gross income so that it can help you prepare for more affordable health insurance. So things like wage and salary, any pay that you receive, Social Security income is included in modified adjusted gross income. Pension income is included, any net business income.

So that’s gross income minus expenses from your business. That is included. Municipal bonds, which I mentioned earlier, generally make interest income on a federally income tax free basis. However, that interest is not free from counting towards modified adjusted gross income, which will affect your health insurance costs. So that is included. IRA, 401(k), 403(b) distributions, any of those distributions from that tax deferred bucket that count towards modified adjusted gross income, as does dividends, capital gains, and interest income from those investments in that non-qualified bucket, which I mentioned earlier. So all of these different sources of income count towards your modified adjusted gross income.

Now, what’s more important than what counts is what does not count. What does not count towards modified adjusted gross income are things like qualified Roth IRA distributions.

None of those distributions from a Roth IRA will count towards your modified adjusted gross income, and none of your basis from the non-qualified investments that we talked about previously. That also doesn’t count towards modified adjusted gross income.

So ensuring that you have enough in that non-qualified bucket where you can pull from the basis and from your Roth IRA or that tax free bucket, having enough in those buckets to get you from retirement to age 65 is crucial to helping you reduce unnecessary costs associated with health insurance.

Why the Issue Matters Today: The Cliff Is Coming Back

Why is this issue so important today? Well, there’s something called the Inflation Reduction Act, which limited the cost of ACA insurance to 8.5% of your modified adjusted gross income through 2025. But after 2025, starting this next year, if nothing changes between now and the end of the year, which we haven’t had any reason to believe that anything will change, the old rules come back and something called the cliff comes back.

So to illustrate how significant the cliff is, I’m going to share with you an example that’ll help get us somewhere in the ballpark of how this might work going back in the future, because we haven’t got total clarity on this. And to illustrate this example, I thought I’m just going to use an example of Wisconsin, which is our home state.

We work with people all over the US in 35 different states. We have a lot of our clients are remote, but for simplicity, I’m just going to use one example. I find this is relatively similar in a lot of other states. However, some of those state-sponsored plans are less severe than people who have ACA insurance through their state.

So I just used an example of a married couple, 62. They’re on a silver plan in my home town here in Eau Claire, Wisconsin. And the way it used to work, as I mentioned, the Inflation Reduction Act limited the cost of insurance to 8.5%. So you can see from 2021 through 2025, while the Inflation Reduction Act has been in place, you can see somebody that had a modified adjusted gross income of $20,000.

They got so many tax credits that their premium was literally zero. They didn’t have to pay anything towards their health insurance to get them to 65. However, once you go up a little bit in modified adjusted gross income, you can see the premium increase to $5,856 per year. So there are deductibles on top of this. But this gives you a general idea of what the costs have been.

And you can see once you exceeded that threshold, the cost stayed relatively similar. Now, if you look at prior to 2021, how things worked—your modified adjusted gross income at $20,000, you still got really affordable ACA insurance. The premium was relatively similar to how it was, very low. And then as you went up, your premium went up a little bit. But the thing that I really want to stress here is the cliff.

And so the way that this used to work, the cliff used to be at $68,961. Once you went 1 dollar above this limit, look at what happens to your premium.

It literally goes up by over $27,000 more per year. That’s what we call the cliff. And that’s significantly different than how it used to be under the—or how it is right now under the Inflation Reduction Act. So we want to do everything in our power as investors and financial advisors to stay under, to stay under this cliff.

Now going forward, in the future, if nothing changes, I would expect this cliff to come back. I don’t know what the numbers are yet, but I’m guessing they’re going to even be more severe than they were. Unless something drastically changes between now and the end of the year.

Strategies to Stay Under the Cliff

What are some strategies you can do to stay under this cliff?

And I should stress that there are people that have million-dollar, multimillion-dollar portfolios that, when they organize their investments correctly and organize their strategies correctly, they can stay under that cliff. Even if you have a high net worth, that does not discredit you from having Affordable Care Act insurance that’s affordable because you can keep your modified adjusted gross income down.

So how do you do that? Well, one thing that you can do is delay your Social Security and any pensions that make sense to delay till after Medicare kicks in.

So a lot of times, Social Security and pension incomes, as you delay them, the amount you receive in the future will actually increase. And there are many people that will debate that that makes sense to delay those things anyway in certain scenarios.

Not always, but for some people it can make sense to delay. Well, if you’re going to be in a situation where it’s going to push you above the cliff, that’s a really big reason to take a close look at delaying Social Security and pension income streams that have scheduled annual increases, and determine if there’s any other income or distributions that are subject to taxation that you can delay post-Medicare age, where it won’t increase your modified adjusted gross income.

Organize Your Buckets

Number two, of course, organize your buckets to provide you with ample income post-retirement pre-65 when Medicare eventually will kick in. You can consider doing things like contributing to the tax efficient buckets like the tax free and the non-qualified bucket. Depending on what your eligibility is with your current employer, or if you’re self-employed or whatever your situation is.

And make sure you consider where to hold different types of investments. So if you’re going to be relying on the basis from non-qualified investments, you might want to make sure that they’re invested more conservatively in a tax-efficient manner.

Because you don’t want to make sure that money is going to be there when you need it.

You don’t want to invest in something that’s higher risk that might be down by 20% or 30% when you need that money.

Minimize Tax Cost Ratio

Strategy number three is minimize the tax cost ratio in that non-qualified bucket. We had talked previously about how certain types of investments have higher tax costs. Other types of investments have much more reasonable tax costs.

It’s very important to make sure this non-qualified bucket is invested in things that are tax efficient, that don’t increase modified adjusted gross income to prevent you from going over that cliff.

Think Beyond Age 65

Strategy number four is not only thinking about, okay, what’s going to be the most efficient way to get me affordable insurance from the age I retire until 65 when Medicare kicks in, but also not losing sight of the fact that you’ve got a lifetime of other considerations beyond 65. So I almost think of this like working on a puzzle.

You can’t just in isolation say that all of the things that I just mentioned you should be doing, you shouldn’t be considering them in isolation of the fact that you will eventually be over 65. And there are certain things that won’t make sense beyond that point. But generally speaking, looking at things like, how can I affordably get ACA or state-sponsored health insurance to the age of 65, anticipating large expenses, future income needs.

Charitable intentions definitely need to be considered because that can reduce modified adjusted gross income. Anticipating the best time to take Social Security. Also, thinking about required minimum distributions from that tax deferred bucket is important and comes into play when you’re doing this type of planning and thinking about current tax rates versus future tax rates.

All of these things are important to consider.

Why Early Planning Matters

I strongly urge you, if you’re going to be retiring before the age of 65 and you don’t have an employer-sponsored retirement health insurance plan provided to you, definitely consider looking at this type of planning as soon as you can, because that helps you organize those buckets well in advance so that you have enough funds to provide you that tax efficient income from the time you retire until the time you get Medicare and age 65.

How We Can Help

With that said, if you are interested in having a virtual meeting with one of our certified financial planners here, all of our certified financial planners do this type of planning on a consistent basis. They can sit down with you, have a conversation. We are very not a salesy type of company, so I think that first call is always the scariest to have.

But you’ll find out very quickly that our certified financial planners are good at asking questions about what you’re worried about, what you’re thinking about for your future, and helping give you ideas on how to organize your assets, how to organize your investments, how to organize your future income streams to get affordable health insurance from the time you retire to the time you’re age 65. I believe a quick 15-minute call is going to be something that you’ll find valuable.

And if you want to do that, you can go to Bernicke.com and schedule a quick 15-minute conversation. At any time, we also will have the link right here for you to click on, so let us know how we can help. I hope you found this valuable today, and I hope you found ways to get more affordable health insurance to get you to age 65 when Medicare kicks in.

And thanks again. My name is Ty Bernicke and I appreciate your time.