One of the biggest challenges with retiring before age 65 (Medicare eligibility) is navigating the complexities of health insurance coverage. In particular, trying to qualify for premium tax credits that help reduce the cost of health insurance purchased on the exchange requires careful planning, with “surprise” income potentially costing early retirees thousands of dollars in additional taxes and in some situations creating a marginal tax rate of well over 100%.
This is because prior to 2021, a “subsidy cliff” was in effect. This meant that if you went even $1 of income above 400% of the federal poverty level based on your family size and location, you were not eligible for any premium tax credits. A small unexpected dividend or interest payment could cost you thousands of dollars in forgone credits. Obviously, this was not ideal for an early retiree with a large taxable account due to potential dividends and capital gain distributions. Early retirees who were potentially eligible for these premium tax credits required a large income buffer to help protect against any unexpected events.
In early 2021 with the passage of the American Rescue Plan Act of 2021, the cliff was temporarily eliminated for 2021 and 2022. Currently, these premium tax credits are subject to a gradual phase-out of benefits based on no more than 8.5% of your modified adjusted gross income (MAGI), although this temporary reprieve is scheduled to expire on December 31, 2022.
If the Manchin-Schumer deal on tax, climate and health care is passed and becomes law in its current form, the “subsidy cliff” will be further delayed to January 1, 20261, the same time the Tax Cuts and Jobs Act of 2017 tax changes are all set to expire. This extension of a more gradual phase-out for health insurance tax credits will likely be a welcomed relief for many early retirees.
About the Author
Michael T. Powers, CPA, PFS, CFP® (Mike), is a flat fee-only financial planner based in Richmond, VA serving clients virtually nationwide. He has been fortunate enough to help hundreds of people successfully retire over his career. As a CPA, being tax efficient in financial decisions is always on his mind.
Photo by Caleb Perez on Unsplash.
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