Friday, December 08, 2017

Planning a two-step retirement, because health insurance

My last post looked at the various ways that self-employed people in particular can limit their taxable income to stay on the right side of the ACA subsidy cliff, which has reached untenable heights for people in their late 50s and early 60s. We're at the point where getting on the wrong side of the subsidy-eligible line can mean $10,000-plus in extra health insurance costs for older shoppers in the individual market for health insurance.

The situation reflects broader societal dysfunction. We have a gaping hole in the safety net patched by an insanely diverse panoply of tax-sheltered accounts -- which some lucky and nimble affluent-but-not-rich people may hopscotch across to safety.

Take the case of a couple of 58 year-olds in a northeast city where the cost of living is high -- their modest dwelling is worth over $600k and taxed accordingly. The wife, Samara, is a hospital nurse, and the husband, Aman, is a solo consultant of some kind. Both have earnings in the $75k range. Thanks to assiduous feeding of their 401k retirement accounts (they've saved a bit over $1 million between them), their Adjusted Gross Income (AGI) is about $110,000 -- far below their gross, but far above the ACA's subsidy eligibility threshold of $64,960. That's not an issue for now, because they get good insurance through Samara's hospital job.

But what if Samara is hoping by age 62 or so to...not retire, but work per diem, or try an encore career? An unsubsidized ACA-compliant two-person bronze plan with per person deductibles in the $6-7000 range  might cost them $1500 or $2000 a month by age 62.  Can the couple get below the subsidy line without a radical cut in income? Can Samara escape health insurance-induced job lock?

If they're willing to cut their current cash flow substantially but not radically, the Byzantine array of retirement accounts available to them suggests a strategy. As I noted yesterday, money withdrawn from a Roth IRA is not taxable and not added to the Modified Adjusted Gross Income (MAGI) that determines subsidy eligibility in the ACA marketplace.

Here's the plan. From ages 58 through 62, Samara and Aman strain some fiscal muscles to top up a Roth IRA -- both have had rather dormant ones sitting around for years, since the more immediate incentive has been to reduce their taxable income by putting as much as they can manage in 401ks. Their Roths had about $25k between them at age 58. Now, executing their plan, they get their combined Roth balances to $100,000 by age 62, while Aman cuts back a bit on his yearly 401k contributions.

As her 63rd year begins, Samara goes part-time and per diem, cutting her gross income from $75,000 to $30,000. Aman continues to earn $75,000. But he goes full-bore on his solo 401k, contributing the maximum allowable $39,500. His self-employment tax deduction gets the couple's MAGI below the $64,960 subsidy threshold. They get a bronze plan that costs under $200 per month for both of them - -maybe a High Deductible Health Plan linked to a tax-sheltered Health Savings Account, if they can stand still more savings. They hope thy don't get sick -- but if they do, the $7,350 per-person out of pocket limits protects their core assets.

But what the hell are they living on? Life's expensive in their northeast town -- their property taxes are about $1500 per month. Well, there's Samara's $30k, Aman's $35k left over after his monster 401k contribution...and a bit over $30k drawn yearly from the Roth IRA. That account is designed to be mostly depleted by the time they reach Medicare age -- while meanwhile, Aman is putting more in the 401k account than they're taking out of the Roth.

In their mid fifties, before executing this plan,  the couple had a pre-tax income of about $150k and were putting about $37k in retirement accounts between them. They upped that to $55k in years 58-62. Now, their pre-tax income, if you count the Roth withdrawals, is about $135k, and they're putting a bit more away  than they did in their mid-fifties and a bit less than in their Roth sprint (Samara continues to contribute on a smaller scale than before to her employer-sponsored 401k). Their 401k contributions modestly outstrip their Roth withdrawals.

Okay, this is a bit far-fetched. The couple is more affluent than most, saves more than most in their income range, and plans long-term for a subsidized individual market that may well not be there soon enough.  It would be more plausible for a couple that had been building Roth savings for a longer time stretch. The broader point is that any substantial Roth savings can be a valuable source of income that doesn't go to MAGI for people in their early 60s.










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