Are you considering early retirement? Whether you’re part of the FIRE (Financial Independence, Retire Early) movement or simply aiming to retire before 65, understanding your early retirement health insurance options is important.
Medicare eligibility begins at 65, so retiring earlier requires careful planning for health coverage. This blog helps you explore the best ways to find early retirement medical insurance and potent senior health insurance plans that suit your needs and financial plan. If you leave the workforce before then, you’ll need to make other arrangements for health insurance—and most come with a hefty price tag.
Suppose you plan to retire before age 65. In that case, you can’t afford to overlook the health insurance implications of your decision and this essential aspect of your retirement planning. Let’s look into the strategies and tips to consider for securing reliable health insurance as you transition into this new phase of life:
Your Early Retirement Health Insurance Options
When you’re in that gap period where you no longer have company-sponsored health coverage but you’re too young for Medicare, health insurance has the potential to take a large bite out of your budget. So, before you take the plunge and retire early, it’s helpful to know your options.
Assuming your former employer doesn’t offer retiree health benefits, you’ve declined to participate in COBRA (or you’ve exceeded the eligibility period), and you don’t have access to affordable insurance as an association member, you’re most likely to turn to the Health Insurance Marketplace. Buying insurance through the healthcare marketplace created by the Affordable Care Act (ACA), found at www.healthcare.gov, is the most common approach for people who no longer have employer-sponsored coverage but aren’t enrolled in Medicare.
You can also choose to buy private insurance outside of the exchange (which tends to be more costly) or use more non-traditional sources like a HealthShare cooperative (which doesn’t offer the same protections or level of coverage as traditional plans), but neither option is advisable for early retirees.
If you buy health insurance through the ACA, as most early retirees do, your premiums will be directly impacted by your income. With proper financial planning, you can reduce the income used to calculate your premiums and avoid overpaying for healthcare until you qualify for Medicare.
How are ACA Premiums Calculated?
Since its inception in 2014, the ACA has provided tax credits to subsidize health insurance costs. Originally, those subsidies were only available to people making between 100% and 400% of the Federal poverty level. Then in March 2021, the American Rescue Plan expanded the subsidies to improve health insurance affordability during the COVID-19 pandemic.
For the 2021 and 2022 tax years, the new act increased the amount of the premium tax credits and capped the premiums at no more than 8.5% of modified adjusted gross income (MAGI), making the tax credits available to some people whose incomes exceed 400% of the poverty level. The expanded subsidies were set to expire at the end of 2022, but the recent Inflation Reduction Act extended them through 2025.
The higher your MAGI, the lower your ACA tax credits and the higher your health insurance premiums. At first glance, this suggests that if your income is high even in early retirement, you may not qualify for the tax credits and could be hit with a large health insurance bill. But proactive financial planning can help you optimize the health insurance premium tax credits while still generating enough income to enjoy the retirement lifestyle you’ve always envisioned.
How to Maximize Your Health Insurance Tax Credits
If your investment portfolio includes a variety of asset types, you may have the flexibility to strategically reduce your MAGI during the years that you’re buying health insurance through the exchange—increasing your tax credits and reducing your premiums. There are two ways to do that: Take a thoughtful approach to tapping different sources of income to cover your living expenses and maximize “above-the-line deductions” that reduce your MAGI.
Planning How to Tap Your Income Sources
On the income side, it’s important to recognize that not all income streams are included in your MAGI as calculated by the ACA. Social Security benefits, pensions, capital gains, and distributions from a traditional 401k or IRA are all included in the calculation, but distributions from a Roth 401k or IRA aren’t.
That means strategies like the following can reduce the income included in your ACA calculations, increase your tax credits, and reduce your insurance premium:
- Delay claiming Social Security until after you’ve reached 65. Not only will this reduce your MAGI and resulting health insurance premiums, but for every year you delay claiming Social Security, your benefits will increase (until they top out at age 70). If you’re married, consider staggering your benefit claims so that the higher earner waits until 70 to begin collecting.
- Determine whether a Roth conversion would be advantageous. By rolling a traditional 401k or IRA into a Roth before you retire, you’ll have the flexibility to draw funds from these accounts in early retirement without increasing your MAGI and driving up your health insurance premiums. A conversion has tax implications, so be sure to consult with an experienced financial planner before moving forward with this strategy.
- Boost your cash holdings before you retire. With more cash on hand to pay your living expenses in early retirement, you’re less likely to draw funds from tax-deferred accounts like a traditional 401k or IRA (which generates a tax bill, increases your MAGI, and reduces your ACA tax credits).
Maximizing Your Deductions
On the deductions side, steps like the following can reduce your ACA health insurance premiums by maximizing your above-the-line deductions and reducing your MAGI:
- Contribute the maximum allowable to a traditional IRA. While you won’t want to tap those funds just yet, the contribution will reduce your MAGI for the purposes of calculating your ACA premium. Note that you can only take a tax deduction for a traditional IRA, not a Roth, and if you’re over 50 you can make an additional $1,000 catch-up contribution.
- Leverage the power of a health savings account (HSA). If you choose a high-deductible health plan that permits you to use an HSA, you can contribute pre-tax dollars up to the maximum allowable and reduce your income. The beauty of an HSA is that it offers a triple tax advantage: Contributions are made pre-tax, your investments grow tax-free, and your withdrawals are tax-free if you use the funds for qualified medical expenses. You can’t use your HSA funds to pay your ACA insurance premiums, but you can use them to cover other healthcare expenses such as deductibles, co-pays, and prescription costs.
How Team Hewins Can Help
The CERTIFIED FINANCIAL PLANNER® professionals at Team Hewins will strive to help you plan for a successful early retirement, including how to prepare for the day when you’re no longer covered by employer-provided health insurance. We can walk you through the various options, discuss the specifics of ACA health insurance, and develop strategies that could help reduce your MAGI (and premiums) without putting a crimp in your retirement lifestyle.
Contact us to discuss your early retirement plans and learn about effective ways to reduce your health insurance costs before you’re eligible for Medicare.
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