Due to the 2016 presidential election, parts of the Affordable Care Act described below may change. The current rules will likely stay in place through 2017. We’ll provide updates as they occur.
When an employer provides health insurance, you receive tax advantages that you don’t get when purchasing health insurance on your own. All the premium costs – whether paid by the employer or employee – are excluded from taxable income (both income tax and FICA taxes).
By contrast, individual health insurance you purchase on your own is paid for with after-tax dollars. These payments don’t receive the same tax advantages, so purchasing $1 of health insurance on your own is more expensive than purchasing $1 of health insurance through your employer plan
To address this, the Affordable Care Act (ACA) created a tax credit for individuals who purchase health insurance through the ACA marketplace. The credit is available to taxpayers earning up to 400% of the poverty level in the current year. For a household of two, that limit is $64,080 in 2017. A taxpayer’s income for this calculation is adjusted gross income (AGI), plus tax-exempt interest and any Social Security that was excluded from taxable income. So a married couple with no kids who earn $50,000 in 2017 would qualify for a tax credit if they had to purchase their own health insurance.
Because tax credits aren’t calculated until the end of the year, you have to pay your health insurance premiums all year in order to get money back when you file your taxes after the end of the year. This is where subsidies come in.
When you sign up for health insurance, you estimate what your income will be during the following year. You use this estimated income to calculate the estimated tax credit you will receive at the end of the year. The government then uses that estimated amount as a subsidy to pay part of the insurance premiums. You only need to pay the remaining premiums not covered by the subsidy.
To qualify for a subsidy in 2017, a household must earn less than this amount of income.
Household Size Income 1 $47,520 2 $64,080 3 $80,640 4 $97,200 5 $113,760 6 $130,320 7 $146,920 8 $163,560
If a family has more than eight people, add $16,640 for each additional person. These numbers are adjusted for inflation each year.
The advantage of this system is it helps reduce the cost of health insurance premiums immediately. However, there is potential risk because your actual income in 2017 might be higher than you estimated at the start of the year. If this is the case, and you took a larger subsidy than you were entitled to, then you may have to pay the excess back when you prepare your tax return for the year.
To mitigate this risk, you can take a smaller subsidy, or none at all. If it turns out at the end of the year you would have qualified for a subsidy but didn’t take it, then the extra will come back to you on your tax return as an additional tax credit.
Planning Opportunities for Retirees
Let’s talk about Steven and Jennifer, a 55-year old married couple who has just retired. They won’t qualify for Medicare for 10 more years, and they don’t have health coverage from their former employer or from any sort of pension. They will have to purchase health insurance on their own for the next 10 years.
Before they retired, they earned over $200,000 per year. Currently, their only income is a $10,000 per year pension that Steven has. Their investments include a $2 million taxable account and $1 million in IRAs. They won’t be taking money out of the IRAs for a while because they don’t want to pay the 10% penalty.
Because the only income they will show on their taxes is the $10,000 pension along with any interest, dividends and capital gains in the taxable account, it may be possible to structure their income so that they qualify for the healthcare subsidy. This subsidy can be worth anywhere from $2,000 to more than $8,000, depending on their age and the state they live in.
Smart tax planning and the availability of subsidies through the Affordable Care Act has made retiring early easier for people like Steven and Jennifer who may have otherwise waited until Medicare started at age 65.