Brian Feutz
How to Exploit the Early Retirement Healthcare Loophole


You want to retire early but can’t afford healthcare.

So, you and millions of other people dreaming the impossible dream keep slogging away at work until you qualify for Medicare. Years of freedom gone because healthcare in the US is stupid expensive.

But…

If you play your financial cards right, you can afford to make your dreams a reality.

Stupid expensive

A new hip costs $40,000 in the US, $13,000 in Mexico, $8,000 in South Africa, and $6,000 in India.

Pharmaceuticals are so expensive, a Utah Public Employees Health Program is sending people to Mexico to buy medications. It’s cheaper to fly them to another country than to pay US prices.

You can get a shiny new knee in the US for $50,000. Or you can fly first class to Paris, get that same knee for $15,000 and spend the rest of your money on luxury spas, a nebuchadnezzar of Bordeaux, and a brand-new Citroen to proudly parade up the Champs-Élysées.

A loophole

While our government representatives whine and bicker over a solution to match the rest of the world, you get older and angrier as you work to fund that elusive retirement.

But there’s no need to wait. You can take advantage of a peculiar healthcare loophole right now.

The Affordable Care Act (also known as ACA or Obamacare) offers subsidies to low-income families. The novel way they define ‘low income’ is a twist you can use to your advantage — regardless of your wealth.

But government subsidies for those of us who can afford it are immoral,” ..said nobody, ever.

So, here’s how you can have plenty of money and still get subsidies:

Start with three rules and one BIG caution

When you follow these simple rules, you can save tens of thousands of dollars in healthcare costs.

1. First, you’ll organize your finances so your retirement income will fall between 1 and 4 times the federal poverty level (FPL). Feel free to spend like a drunken sailor but you absolutely must keep your ‘income’ (as defined by ACA rules) within that range. More on that in a minute.

2. Next, you’ll buy your healthcare insurance on the ACA exchange at healthcare.gov. It’s the only place you can get government subsidies.

3. Finally, and this is the good part, your income only matters during the time you receive benefits. The million-dollar paycheck you got last year doesn’t count. The Lamborghini in your driveway doesn’t count. Only your income — as they define it.

BIG CAUTION: The devil’s in the details here. If you accidentally miscalculate, and your income falls just one dollar over the threshold, you’ll be forced to pay back all your subsidies when the tax man comes calling. That will be a whopping tax bill that you’ll regret.

Exploiting the loophole — pay attention to this

You can chase your dreams later. Right now, you need to understand these details.

Income

The IRS wants you to estimate what your income will be during the time you receive benefits. They define income as “MAGI” or “Modified Adjusted Gross Income,” which is a slight modification of what you expect your adjusted gross income to be.

This 1040 form snippet shows how to estimate your AGI. Add up all the taxable sources of income you’ll expect to receive during that time, such as wages, pensions, alimony, interest, tax-deferred withdrawals, rents, and the like.

AGI — Adjusted Gross Income (from IRS form 1040)

Then, once you have your AGI, you need to modify it by adding back in the non-taxed portion of social security income you’re taking (usually only 15%). Better — if you’re not taking SS right now, you might want to delay that to make it easier.

You may also need to add back in some obscure deductions such as certain types of foreign income, tax-exempt interest, and a few more that most of us will never experience. Talk to a specialist if you’re not sure.

For many of us, our AGI and MAGI numbers are the same.

The loophole: They don’t care about your already-taxed money.

We all have money in checking and savings accounts that we already paid taxes on. That money never shows up on any IRS tax forms, so isn’t considered when calculating ACA subsidies.

So the simple solution is to split your living expenses between already-taxed and not-yet-taxed money, in a way that the not-yet-taxed money falls between 1 and 4 times the FPL.

It’s simple when you think about it but remember the BIG CAUTION above. If you miss the mark, you’ll have to pay back all your subsidies. Ouch.

But, when you do it right, you’ll save a ton.

How much will you save?

A shit ton!

Suppose Mr. and Mrs. Dingle live in Washington State, retired at age 60, spending $100,000 a year, most of which they pull from their not-yet-taxed IRA’s. Their MAGI income is greater than 4x the poverty level, so they pay full price for their coverage, about $1,700 a month for a silver plan. By the time they’re eligible for Medicare, they’ll have spent $102,000 on healthcare premiums alone. Ouch.

Now suppose Mr. and Mrs. Smartz are in the same boat as the Dingles but pull $60,000 from their already-taxed savings account and only $40,000 from their IRAs. For the exact same coverage, they’ll pay just $392 a month — saving $78,000 over the Dingles.

Savings on health insurance premiums for a couple

Cash poor?

Some of us have plenty of money in retirement accounts, but not enough already-taxed money in savings to take advantage of the loophole.

If that’s the case, you could keep working and direct as much as you can into post-tax savings.

Or, you could consider withdrawals from your tax deferred accounts before you retire. Depending on age and income level it might make sense. In a recent article “Seriously, How Much Do You Need to Retire?”, I showed that marginal tax rates don’t change much between $80K and 170k in income for a couple. Talk to a professional before doing that of course.

Be smart. Take extreme care! This is your money and your retirement

Some caveats:

· For simplicity and brevity, this article has left out a lot of detail. And remember I’m not a licensed financial advisor, so be sure to discuss this idea with your advisor to confirm it’s a good choice for you.

· If you make a tragic math mistake and your MAGI is even $1 over the threshold, you’ll have to pay back all the subsidies when you file your tax returns. That’s a lot of money, so be careful.

· We didn’t talk about ‘cost-sharing’ subsidies. If your MAGI is low enough, your out-of-pocket and deductibles will be reduced as well, saving you even more.

· Healthcare costs on the ACA marketplace vary significantly by plan and location. This article uses average 2020 plan costs in Seattle as an example. Using this tactic in other regions may have different results.

· State income tax should be considered if you’re considering tax-deferred withdrawals before retirement. Washington State does not have one, but in states that do, your savings could be lower.

· To take IRA and 401k deferred fund distributions without penalty, you usually need to be at least 59.5 years old. If you’re younger than that be sure to consider the extra cost of penalties.

· Be aware of your investments in Mutual Funds. They may generate tax liabilities even if you don’t withdraw money.

· Be sure to make quarterly tax payments to avoid extra fees.

· You’ll find great resources on https://www.healthcare.gov/

· Enjoy your retirement!



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