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 As I noted yesterday, money withdrawn from a Roth IRA is not taxable and not added to the Modified Adjusted Gross Income (MAGI) that determines subsidy eligibility in the ACA marketplace.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.


  1. Am I getting this right?

    A 2/10/17 article in Atlanta’s major daily called my attention to another issue in subsidy cliff avoidance. A retired couple has one partner, age 60, beginning her final, high-premium, pre-Medicare years while the other partner, 70+, will be subject in those same years to mandatory minimum required disbursements (MRD’s) from his retirement accounts.

    Certainly, there will be cases where those mandatory withdrawals could be large enough to drive the couple over the cliff. The couple featured profess that they are indeed trapped and their “carefully planned retirement” has been “absolutely ruined”; in actuality, it seems that they have missed fairly obvious steps that would have made it possible for them to avoid the cliff for 2018.

    Importantly though, they have an excellent chance to avoid the cliff for 2019 through 2023, when the younger partner hits Medicare), just by converting a substantial measure of their existing retirement accounts to Roth IRAs during their unsubsidized 2018 tax year.

    Concentrating income into 2018 for the transfer to Roths likely result in some of that income being taxed at a higher marginal rate, but the move could seize a lot more in ACA subsidies. If for example, the couple needs to reduce retirement income by $5,000 a year to make the subsidy threshold of $65,000, they would need to reduce the balance of their non-Roth retirement accounts by about $100,000. This might cost the couple $6,000 in higher taxation, but bring in 4 years of $10,000+ subsidies. A great investment?

    AJC article is at

  2. Actually, Ragbatz, I don't understand this couple's plight. The story doesn't say the 70 year-old "has to" make retirement withdrawals that put him over the subsidy line. It says their income is $48k, at which level his wife can get a bronze plan for $136/month, but that he'll "have to" withdraw from his retirement savings to pay all their bills. The subsidy line for 2 is just under $65,000. At $64k, cheapest bronze would be $269. Why would he top off income over that level?

  3. Agreed. In part, that's why I wrote "that they [may] have missed fairly obvious steps" and used scare quotes for “carefully planned retirement”. It’s also why I all but begged reporter Ariel Hart and her editor for a correction or supplement making clear that $48,000 - $64,000 families are safe and that $65K plus families likely have better options than going without insurance or selling their home.

    For this family, one possibility is that (a) he turned 70 1/2 prior to July 1, 2017, (b) he was therefore required to take an "MRD" distribution for 2017 sometime before April 15, 2018, (c) he neglected to read xpostfactoid in December 2017, (d) he failed to take the 2017 distribution in 2017; and (e) the is therefore being forced to take both his required MRDs for 2017 and 2018 in calendar year.

    Only the taxpayer’s initial year’s MRD is allowed to be pushed forward like that, here perhaps resulting in his being forced to extract, in a single year, about 7.5% of the balance in his retirement accounts. If that balance on December 31, 2017 was anywhere north of $285k, and they cannot shed any of their $48k in other income, he could really have this exact problem. [Which , it should also be noted, might evaporate when the double MRD year has passed.]

    There are other ways the family could have gotten into this fix, if indeed they are actually in it. They may just be clueless. Or they may have deliberately hoodwinked the reporter into creating an especially grim, if vague, story that matched their politics.

    Putting this family aside, however, the two hopefully useful things I wanted to share with your readers were (a) the significance of compulsory minimum distribution rules for retirement accounts and (b) to be aware that one trip over the cliff is not the end. A single year over the cliff is a better-late-than-never window in which conversion from traditional retirement to Roth accounts should be carefully considered.

  4. [REVISED]
    Andrew, although it is not clear in the article, he may well be forced to top off. He certainly will be making a compulsory withdrawal for 2018. In any case, the issues around compulsory withdrawal go beyond the particulars of this couple.

    For each year beginning with the year in which a taxpayer turns 70 and 1/2, that taxpayer is required to take a minimum distribution from his (non-Roth) IRA accounts. If retired, the taxpayer must also begin taking distributions from his employer sponsored retirement plan. “RMD” payments for the first year, but only the first year, can be postponed until April of the following year. As the retired husband in the article is 70 now, he will owe an RMD for 2018. If his accounts had a balance of $467,000 or more on December 31st, 2017, he will need an RMD of over $17,000. Add this to $48,000 of other income, and his family falls over the subsidy cliff. Depending on his exact birthday, 2018 will be either his first or second RMD year.

    For this family, it could be that: (a) he turned 70 prior to July 1, 2017; (b) was therefore required to take an "RMD" distribution for 2017 sometime before April of 2018; (c) failed to take the 2017 distribution in 2017; and (d) is therefore being forced to take both his required RMDs for 2017 and 2018 in calendar year. He would be forced this year to accept about 7.5% of the balance in the accounts. If his traditional retirement balance on December 31, 2016 was anywhere north of $285k, and the family cannot shed any of that $48k base income, over the cliff they go.

    There may be other ways they could have gotten themselves into this fix, although I have difficult imaging any other scenario that could not be solved by clever financing. That’s why I wrote that “they have missed fairly obvious steps” and why I used quotes around “carefully planned retirement”. It’s also why I all but begged reporter Ariel Hart to write a corrective piece making clear that $48,000 - $64,000 families are safe and that $65K plus families likely have better options than going without insurance or selling their home.

    I do not discount the possibility that this family deliberately hoodwinked Ms. Hart into creating an especially grim, if vague, story that matched their politics while masking their own questionable choices and retirement planning errors.

    Putting this family’s details aside, I thought there might be two useful lessons. First, these compulsory minimum distribution rules should inform ACA planning for couples with one retired partner in Medicare.

    Lesson two: a trip over the cliff is not the end. A single year on the wrong side is a better-late-than-never window in which defensive actions to protect future subsidies are, in sense, somewhat protected.

    If you are going over the cliff in because of too much MAGI in a given year, grab all the MAGI you need to protect future subsidies. For the couple in the article, conversion from traditional retirement to Roth accounts during 2018 could still avoid their “carefully planned retirement” being “absolutely ruined”.

  5. Thanks for this. Mandatory distributions from retirement accounts are for sure a potential ACA subsidy-buster, though the couples would have to be more than 5.5 years apart in age.

    I would not want to suggest even the possibility that this couple intentionally hoodwinked anyone, and I would guess that they are subsidy-ineligible, either in the way you outlined or in some other way. My point was mainly that vital details seem to be missing from the story.