You want to retire early. But you’re afraid to give up your company’s health insurance.
You’re worried it will cost too much on the open market. And with good reason.
The average cost of health insurance was $456 per month for an individual and $1,152 for a family in 2020. And it keeps rising every year.
Insurance would become a huge chunk of your budget. How can anyone afford to retire before Medicare kicks in at age 65?
There’s good news. With smart planning, you can make health insurance affordable and keep your early retirement dreams. Here’s how.
Affordable health insurance for all?
The Affordable Care Act (ACA)—aka Obamacare—is the government’s attempt to make health insurance affordable for every American. It does this by paying subsidies, in the form of tax credits, to people with Modified Adjusted Gross Income (MAGI) between 100% and 400% of the Federal Poverty Level (FPL).
Below 100%—and up to 138% in some states—people are covered by Medicaid. Above 400%, they’re generally considered to have enough income to pay for health insurance on their own. Exceptions have been made through 2025 through the Inflation Rescue Plan and Inflation Reduction Act. These laws extended subsidies beyond 400% in some cases where health insurance would otherwise cost more than 8.5% of income.
I will do my best to keep this article up to date. But lawmakers are constantly looking at changing ACA rules. So make sure to check healthcare.gov for the latest official details if you’re ready to enroll.
Table 1 gives the 2023 FPL. Hawaii and Alaska’s poverty levels are higher. The full guidelines are here.
The 400% FPL numbers are respectable incomes. But depending on your individual case, you may get a much higher subsidy and additional “cost-sharing reductions” if you can keep taxable income well below 400%. You’ll also be required to select a mid-level Silver plan to get the cost-sharing reduction. You can see this by entering some basic information at the HealthCare.gov lower-costs page, which will take you to your state’s marketplace if it has one.
Now let’s look at what this might mean for you as an early retiree.
How early retirees can make health insurance affordable
As an early retiree, you have built a good amount of wealth. And you have a long life ahead of you. So you probably want to avoid Medicaid since it can result in lower quality treatment and having certain procedures and treatments denied. ACA plans will give you more control over your healthcare.
Your target income, then, will be somewhere between 150% and 400% of the FPL. But how do you control your income?
Use multiple types of accounts with different tax treatment
If you follow conventional financial advice, you’re saving for retirement in some combination of these 3 account types:
- Tax-deferred: Traditional IRA or 401k
- Tax-free: Health Savings Account (HSA), Roth IRA or 401k
- Taxable: brokerage, high yield savings account, TreasuryDirect (gov’t bonds) earnings
If you’re following PathwayToFI, you’re putting your retirement savings in these accounts first.
Either way, you’re saving aggressively enough to retire early. So you should have a good amount of money in each type of account.
When you draw money from tax-deferred accounts, 100% of it is taxed as ordinary income. That’s because you didn’t pay income tax when you made the contributions.
When you draw money from tax-free accounts, none of it is considered taxable. The HSA never has and never will be taxed if the money is used for qualified medical expenses such as health insurance! And you already paid income taxes when you made the contributions to a Roth.
When you draw from taxable accounts, you only owe taxes on your investment gains. You already paid income taxes on the original investment. The cash basis that you originally invested is “post-tax”.
Having these 3 account types allows you to plan out how much income you want to claim in a specific year.
Generally, you’ll take money out of taxable accounts first, and calculate the investment gain. Then you’ll take tax-deferred money up to the income you want to claim for taxes and ACA subsidies. Finally, you’ll use tax-free money if you need more income to cover expenses for the year.
Note that the income you use to figure out the ACA subsidy is higher than what you report for taxes because it doesn’t include any deductions.
Control your income to balance the ACA subsidy with your desired lifestyle
A good place to start planning for ACA subsidies is the calculator at KFF.org. It’s quicker than getting exact numbers from HealthCare.gov. But you’ll eventually want to go to there also.
I built the following tables using the US Average subsidy for 2023 in the KFF calculator. I assumed the adults were age 40 and children age 10. For older adults, subsidies appear to increase, but the premiums stay the same. You can play with the calculator for your own state and family details if you want to see how they compare.
The Difference column shows how much more you might pay for health insurance if you increase your income another 50% of FPL.
The % Income column shows how much your premium costs as a percentage of your income.
This percentage can also be seen as an effective tax increase over the full subsidy that a family receives at the poverty level. Looking at it as a tax increase instead of a lost subsidy is useful for tax planning because you can add it to your marginal income tax bracket to find out how much you will be “taxed” for additional income.
When you buy ACA health insurance, every dollar in subsidy that you get is the same as paying a dollar less in taxes.
Example: controlling effective tax with income planning
Here’s how an early retiree might control income to optimize health insurance and taxes.
Let’s assume you have a family of 4, live in Colorado where there is a flat 4.4% income tax, and are planning for an income of $75k. You’re looking at the 3 options in Table 5.
If you took all $75k from tax-deferred accounts and taxable dividends, you would be in the 12% marginal federal income tax bracket and would pay an effective “tax” of 4.8% through your health insurance premium. Adding all these forms of tax gives you an effective marginal tax rate of 21.2% on your last dollars earned.
You could also choose to take $60k in taxable income. The other $15k could come from a tax-free source like your Roth or from post-tax cash in your savings account. Then you’d remain in the 12% federal bracket but would pay only 2.7% in insurance premiums. So your overall tax reduces by 2.1% to 19.1%.
If you really wanted to keep taxes low, however, you could keep your taxable income at $45k and take the other $30k from tax-free or post-tax sources. In that case, you would drop to the 10% federal tax bracket after taking the standard deduction. And your insurance premium “tax” would drop to 0.5% because of high subsidies. This would drop your effective marginal tax to just 14.9%.
Note that the health insurance premium “tax” is on every dollar of income, not just the last marginal dollar earned. So a drop of 2% in insurance premium “tax” is worth more than a 2% drop in your marginal federal tax bracket.
Maximize the ACA subsidy while you can
The last thing I will say about planning your taxable income around Affordable Care Act subsidies is that we don’t know how long they will last. There has been constant political pressure on the ACA ever since it was put into law. So my advice would be to make the most of the subsidy while you can.
On the other hand, federal tax brackets are historically low. So if you’re in the 10% or 12% marginal bracket you should consider making the most of those too.
Whether you go to the top of the 10% or 12% brackets will have a lot to do with how much money you have in tax-deferred accounts. If you max out the 10% bracket and are only drawing 2% of your tax-deferred assets, you probably need to go to the 12% bracket. If maxing out the 12% bracket takes 8% of your tax-deferred assets, it might be too much.
Work with your account and financial advisor or coach on the specifics of your situation.
Summary
ACA subsidies are a great tool to get affordable health insurance for early retirees. Without subsidies, health insurance would keep many people from retiring early.
Use the tables above, calculator, or health insurance marketplace to see how much you can expect to pay. Make sure you have enough money in taxable, tax-deferred, and tax-free accounts to keep your income below 400% of the Federal Poverty Level. Then you can confidently plan for affordable health insurance in retirement!
Read these articles next to continue planning a great retirement:
- How to Plan for Irregular Spending in Retirement
- Getting the Big Things Right in Retirement Planning
- Secrets to Getting Money Out of Your Retirement Accounts Early
And don’t forget to sign up for FREE at the bottom of the page to get much more value from PathwayToFI.
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