Elimination of the ACA “Subsidy Cliff”?

As part of the recent tax proposals, one potential change that’s not getting much attention in the early retirement community is an elimination of the affordable care act (ACA) “subsidy cliff.” As I wrote back in June, previously there was an income limit based on 400% of the federal poverty level (FPL) based on family size. Individuals, families and couples who exceeded this 400% threshold by just $1 could lose out on thousands of dollars of premium tax credits.

In March with the passing of the American Rescue Plan Act of 2021 (ARP), individuals on the ACA were temporarily given reprieve on the subsidy cliff and were instead subject to a gradual phaseout of benefits based on no more than 8.5% of their modified adjusted gross income (MAGI) for 2021 and 2022. This was a huge change for many people on the ACA and was welcome relief to many early retirees, as in the past I witnessed several cases where an unexpected year-end dividend or capital gain distribution cost pre-Medicare retirees thousands of dollars in lost premium tax credits.

While the ACA is certainly not perfect, if this change is made permanent, it will make planning for health insurance before Medicare more straightforward and easier to understand, at least when looking at the expected monthly premiums.  And while the health insurance coverage available often carries a high deductible, it provides maximum out-of-pocket protection against the catastrophic medical issues many early retirees fear could derail their financial plan.

For example, before the ARP was passed in 2021, a couple aged 60 and 63 living in West Virginia with $68,900 of income would have received a premium tax credit of $2,709 per month ($32,500 for the year) to help cover health insurance costs of $3,273 per month. If they had $69,000 of income, their premium tax credit would have been zero.  So there was an incredibly negative incentive if you earned anything over $68,960 (the actual “cliff”), as $1 of additional income could cost you $32,500 worth of tax benefits.

Now after the ARP was passed, in 2021 that same couple would receive a premium tax credit of $2,784 per month with $69,000 of income for the year, an increase of $33,408 per year of benefits.  In fact, they would continue receiving some premium tax credit assistance until their income hit roughly $462,000, fully phasing them out.

[Note that premium tax credit assistance may be lower for covered individuals who are younger and/or live in states where health insurance premiums are lower, but as you can see in this example the premium tax credits can be huge.]

Health insurance is by far the biggest reason I hear people express hesitation when considering starting a new business or leaving their current job before they turn 65, even if they have sufficient resources to maintain their current standard of living. If these proposals are passed, my guess is that it will help a number of them feel more comfortable making decisions to leave their current roles and pursue their passions, whatever that may be.