One of the biggest risks for the early retiree has been the rising cost of health care and the pressure on savings when health issues arise. The Affordable Care Act could reduce that risk.
We've all seen it--clients who are unrealistic about their spending habits, overly optimistic about the strength of their portfolios and the direction of the markets, and who just can't wait to embark on a leisurely retirement in their 50s or early 60s. But all too often, health-care expenses in the period between early retirement and Medicare eligibility have cratered those plans and dreams.
Enter Obamacare. Love it or hate it, the Affordable Care Act (ACA) offers an element of predictability in the health-care marketplace. Premiums based on pre-existing conditions are a thing of the past. The only criteria for setting premiums are age, geography, family size, and whether or not the applicant is a smoker. And, interestingly, not all states consider smoking status when setting premiums.
Levels of Coverage
There are four levels of coverage designated as Bronze, Silver, Gold, or Platinum. Premiums are lowest at the Bronze level and highest at Platinum. The difference is the out-of-pocket costs, which are highest for Bronze and lowest for Platinum. Bronze plans cover approximately 60% of the enrollee's total cost, 70% for Silver, 80% for Gold, and 90% for Platinum.
All plans must cover "essential health benefits" such as preventive care, prescription drugs, lab services, mental health treatment, pediatric care, maternity care, hospitalization, and emergency services (with no pre-authorization required). There are no longer lifetime limits on the amount of coverage.
Under the old rules, basically there were no rules. The insurance companies could use occupation, age, health history, or more to determine premiums. Under the ACA, rates for older adults cannot exceed three times the rate of a younger person. This is the heart of the concern that not enough young people will participate in ACA plans for the economics to be financially viable. However, this pricing restriction can be very beneficial to the younger retiree.
This is where the planning opportunity comes in. Government subsidies in the form of a tax credit will be available to help pay insurance premiums based on income. This assistance is available for people with family income that is between 100% and 400% of the federal poverty level. For 2014 that range is $15,730 to $62,920 for a family of two.
Premium calculations for purposes of the subsidy are based on the second lowest-cost Silver Plan, although the participant is free to choose a higher- or lower-cost plan. The maximum premium for those eligible for the subsidy is between 2% and 9.5%, based on family income. Since health-care premiums are higher for older people but the amount of the subsidy is based on income, the older enrollees derive a greater relative benefit.
Family income is defined as modified adjusted gross income (MAGI) using the IRS definition. MAGI includes wages, salary, foreign income, interest, and dividends. It also includes non-taxable income (i.e., muni bond interest) and non-taxable Social Security income. MAGI does not include income in the form of gifts or inheritance, and it does not take assets into account.
Here's how it works:
>> Sally and Russell are 62-year-old non-smokers earning $40,000 per year. This is 258% of the Federal Poverty Level
>> Their maximum premium is 8.28% of income, or $3,312 per year ($276/month)
>> Annual premium for the Silver Plan is $14,500 (varies by state)
>> Government subsidy is $11,188 (77% of the plan cost)
>> Premium cost for Sally & Russell is $276 per month if they choose the Silver Plan
>> In this Silver Plan, the maximum annual cost for health care is capped at $12,700 over and above the premium. Preventive services are covered without cost sharing.
>> For planning purposes, the worst-case scenario would be health-care costs of $16,012 per year ($3,312 premiums + $12,700 out-of-pocket expenses), or $1,334 per month.
>> Cost sharing varies according to the plan type. A Platinum plan would have the highest premiums and lowest cost sharing limits.
How to Enroll
An open enrollment period will be scheduled at the end of each year to purchase coverage effective the following year. 2014 open enrollment is Nov. 15, 2014, through Feb. 15, 2015. Coverage begins Jan. 1, 2015, if enrolled by the end of 2014. Enrollment may also be allowed throughout the year if there is a qualifying event such as marriage, birth of a child, or loss of employer coverage.
Is There a Catch?
The premium subsidy is only available for participants who sign up using the exchanges, also known as the marketplace. Participants who purchase qualifying plans through health insurance brokers are not eligible for the tax credit. Clients who prefer to use a specific physician may find that the doctor participates in broker-sold plans, but not necessarily in the exchange-offered plan.
Individual health insurance plans in place on or before March 23, 2010, are grandfathered under ACA. They are not required to provide the essential benefits mandated by the ACA and therefore do not qualify for the premium subsidy.
What Happens if the Participant Makes Too Much Money?
This is similar to any other underpayment or overpayment of taxes. When applying for health insurance on the exchange, applicants give their best guess as to income for the coming year. They can apply all, part, or none of the subsidy to the premium. At tax time, the account is settled as part of the personal income tax filing. If the income estimate is too high, some or all of the subsidy may need to be returned. If income is lower than expected, or if the taxpayer elected not to apply the subsidy to the insurance premium, the subsidy will come in the form of a refund.
Making the Numbers Work
>> Lower the MAGI--Bronze plan participants may be able to contribute to a Health Savings Account, which reduces the MAGI.
>> Contribute to an IRA--If the early retiree has worked part time or retired during the year, he or she may be eligible for a deductible IRA, which will reduce the MAGI--a great last-minute planning opportunity.
>> Prepare income and dividend projections for the existing portfolio.
>> Consider dividend and income before making changes to asset allocation.
>> Determine whether or not smoothing income or staggering high- and low-income years provides the greater benefit.
The system was designed to make health-care costs comprehensive and affordable at all income levels. Right or wrong, by ignoring assets as a criteria, the system can also provide benefits for those who are relatively affluent. Whether or not the early retiree is eligible for subsidies or prefers to shop outside the exchanges, advisors now have better tools for predicting future health-care costs than in the past. Removing the fear of financial ruin due to unpredictable health-care costs should make for a more carefree retirement.