As we discussed in part two of this series, there are a few main ways that an early retiree would cover their health insurance needs in retirement. The majority of early retirees that we work with opt for healthcare through the ACA Health Insurance Marketplace. The benefit of getting your healthcare through the ACA is federal subsidies that are provided based on income levels. But, there is one problem with ACA subsidies: what if you have a large traditional IRA and you would like to start converting traditional money to Roth money? This will increase your taxable income and thus reduce your ACA subsidies. Let’s break down this balancing act and look at some considerations for how to approach this problem.
Understanding the Tradeoff
The core issue here is that Roth conversions increase your Modified Adjusted Gross Income (MAGI), while ACA subsidies are more generous the lower your MAGI. It’s a classic case of short-term vs. long-term benefits:
- Roth conversions can provide tax-free growth and withdrawals in retirement, potentially saving you significant money in the long run.
- ACA subsidies can dramatically reduce your healthcare costs in the years before you’re eligible for Medicare.
So how do you decide which to prioritize? Let’s dive deeper into the considerations.
The ACA Subsidy Sweet Spot
ACA subsidies operate on a sliding scale based on your income. In 2024, for a household of two, subsidies start phasing out at an income of $20,440 (100% of the Federal Poverty Level) and completely disappear at $81,760 (400% Federal Poverty Level) in states that haven’t expanded Medicaid. These levels vary based on household size and change year to year, so check here for the most current levels.
If your income is below the 100% Federal Poverty Level threshold, you might actually benefit from doing some Roth conversions to increase your income and qualify for subsidies, otherwise you could actually end up qualifying for Medicaid, which often has lower quality of service than what you would receive through the ACA Marketplace. On the other hand, if you’re near the upper limit, additional Roth conversions could cost you thousands in lost subsidies.
Roth Conversion Considerations
When evaluating Roth conversions, consider:
- Your current tax bracket vs. expected future bracket
- Your overall retirement savings balance and composition
- Your expected retirement income and spending needs
- State taxes
Remember, the goal of Roth conversions is to pay taxes now at a lower rate than you expect to pay in the future if and when you take distributions from a Traditional IRA. If ACA subsidies push your current tax rate higher than your expected future tax rate, it might make sense to delay conversions or forgo them entirely.
Strategies for Balancing
- Time your conversions: Consider doing larger Roth conversions in years when you’re not relying on ACA subsidies, such as if you have COBRA coverage after leaving your job.
- Partial conversions: Instead of all-or-nothing, consider smaller conversions that keep you within subsidy limits.
- Look at the long term: If you expect significantly higher income in retirement (perhaps due to large Required Minimum Distributions), it might be worth sacrificing some ACA subsidies for the long-term benefits of Roth conversions.
- Consider your health: If you have high healthcare needs, the immediate benefit of ACA subsidies might outweigh potential future tax savings.
- Use other income sources: If possible, rely more heavily on Roth or taxable account withdrawals during ACA subsidy years to keep your MAGI low.
There’s no one answer to the Roth conversion vs. ACA subsidy question. Your optimal strategy will depend on your unique financial situation, health needs, and retirement goals. This is a complex area where working with a financial advisor, like the professionals at Farnam Financial, can provide significant value. Schedule a 30-minute consultation today!
