Rising health care costs can be a risk at any age. If you want to or need to retire early, health care costs are an especially important part of retirement planning, since Medicare doesn’t kick in until age 65. That means you need to find health insurance at a time when you’re vulnerable to higher costs and also lack a paycheck.
The Affordable Care Act (ACA) was intended to make insurance more affordable and equitable, eliminating previous pre-existing condition requirements and tying income to federal health insurance subsidies. These subsidies are triggered, provided your income meets certain thresholds, when you purchase health insurance either through the federal health care exchange at healthcare.gov or a state insurance exchange. In 2021, there were 15 state-run marketplace exchanges that serve residents of those specific states; everyone else is served by the federal ACA marketplace exchange.
For 2021 and 2022, some special rules were introduced through President Biden’s American Relief Act designed to increase health insurance affordability for those with current marketplace coverage, those who are uninsured and those who lost employer coverage during the pandemic. Subsidies have risen for every income level, and premiums are capped at 8.5% of adjusted gross income.
Those changes mean that an additional 3.7 million individuals are eligible for subsidies, providing an average savings of $70 a month for those with incomes between 400% and 600% of the federal poverty level. That new threshold increases the subsidy cutoff up to $76,560 for single individuals or $157,200 for a family of four. For ACA subsidy purposes, income is based on your tax return’s adjusted gross income plus any tax-exempt foreign income, tax-exempt Social Security benefits and tax-exempt interest.
The Act also eliminates the requirement to pay back tax credits in excess of their adjusted income. For those who lost their employer-tied health insurance during the pandemic, the government will pay their entire COBRA premium through September of the current year.
Better insurance coverage is, for the time being, available at an all-time low price. This will not continue past 2022, unless Congress acts to make it permanent. In the meantime, if you’re thinking about retiring, here are three strategies designed to help you reduce your health insurance costs between retirement and age 65 by maximizing the savings you can receive through ACA subsidies. While it’s important to obtain a subsidy, you also want to comfortably and sustainably live your retirement lifestyle.
Strategy #1: Delaying Social Security
How much you get in Social Security depends on a sliding scale set by the Social Security Administration based on your age, how many years you worked, how much you contributed to Social Security and when you claim. Although you can claim starting at age 62, the payments rise for every month you delay claiming until age 70, when your benefit hits its maximum.
Social Security income is counted as part of your income for calculating insurance premiums on the marketplace. Therefore, claiming Social Security later will lower your income and enable you to get higher subsidies in the intermediate years between when you retire and age 65, when Medicare kicks in.
Delaying claiming Social Security is therefore beneficial to your entire retirement strategy, because it results in higher ongoing income when you could really need it in middle or late retirement. Married couples especially can take advantage of Social Security claims strategies to minimize health care costs. For example, the lower-earning partner could claim early while the higher-earner can wait to claim — this minimizes income for the couple that counts toward the current health insurance subsidies.
Strategy #2: Minimize Withdrawals from Retirement Accounts
Along with Social Security, withdrawals from 401(k)s, IRAs and similar accounts are counted toward the income that determines the level of health care subsidy you get. Therefore, if you want to retire early, it’s important to avoid withdrawing large sums from tax-deferred retirement accounts that could impact your potential subsidies.
Because you aren’t required to take distributions until you turn 72, careful planning can help you avoid the kinds of excessive withdrawals that might negatively impact your health insurance costs. Consider boosting your withdrawals from the IRA in the year or years before you retire and putting that money aside in a liquid savings account, which you can then tap in early retirement to pay your expenses between when you retire and age 65.
If you have some wiggle room in tax planning right now, you should also think about converting your IRA into a Roth IRA to reduce the taxes you’ll have to pay once you’re retired and taking distributions. Should you already have a Roth IRA, you are also able to make early withdrawals in this manner, if necessary, since Roth withdrawals aren’t counted toward income under the ACA.
Strategy #3: Build a Cash Cushion
In the years immediately before retirement, there’s a lot you can do to limit your exposure to any unexpected health care costs. Before you’re retired, you should generally be directing any additional savings toward the liquid savings account mentioned above. At least a year before you want to retire, consider if you have any capital gains from taxable investment accounts and putting them there as well. Do the same with any sudden windfall you get: a bonus from your job, an inheritance or gift.
The idea is to build up this liquid savings account so it will cover all or most of your expenses in the year or years between your retirement and age 65, when you can access Medicare. To be clear, this cash cushion isn’t merely designed to pay your health care expenses, its bigger purpose is to ensure that you’re living the retirement lifestyle you imagined before retirement.
In these years many retirees take on part-time work to provide extra income that will cover the gap between your expenses on the one hand and your savings and Social Security income on the other, a strategy well worth considering in the intermediate years.
A final word
Health care expenses in retirement can create headaches and even negative financial consequences. By delaying Social Security and minimizing withdrawals from IRAs and other retirement accounts in early retirement, you can maximize the health insurance subsidies you receive under the ACA. Before retirement, you can act to build up a liquid savings account to meet health-related expenditures you incur in the years in between when you retire and when Medicaid becomes the major contributor to your health care needs.
You shouldn’t have to spend time, energy or emotion worrying that you won’t be able to pay for all the treatment you might need during what are supposed to be times of relaxation and enjoyment. Fortunately, through careful advanced planning, we have the ability to lessen or eliminate these headaches altogether.
President, Bellue & Associates Financial Management
Brady Bellue has been in financial services since 1997. He attributes his success to lots of research, being proactive, continually learning and always being available to his clients. Brady received his early experience in Chicago and New York before moving back to Wisconsin, where he has run his own business, Bellue & Associates Financial Management, since 2000. He prides himself on staying on the forefront of financial trends and innovations.