Jon Muller is a semi-retired policy analyst and entrepreneur.
The Inflation Reduction Act (IRA), which Democrats in Congress approved and President Joe Biden signed in 2022, eliminated the subsidy cliff for health insurance purchased through the Affordable Care Act exchanges through 2025. It used to be the case that your ACA health insurance subsidy disappeared with the first dollar earned over 400 percent of the Federal Poverty Level (FPL).
Unless Congress acts to continue this provision of the IRA, the subsidy cliff will return in January. Thus far, Republicans in Congress show no interest in extending the enhanced subsidies for ACA health insurance plans.
The FPL in 2025 is $15,650 for a single person and $21,150 for a married couple. Thus, 400 percent of FPL is $62,600 and $84,600, respectively. A single person earning $62,600 currently pays $434/month on the Exchange for a Silver Plan. The married couple at 400 percent of FPL pays $599. The FPL increases with each dependent.
Under current law, a 60-year-old single person making just one extra dollar, or $62,601, experiences a rate increase of less than 1 penny/month. When the subsidy cliff returns in January, those premiums will go to $870/month, or an additional $5,119/year. For a 60-year-old married couple earning $1 more, the monthly premium will increase to $1,512, an annual hit of $10,953. These estimates are based on average rates for non-smoker 60-year-olds in Iowa. The increases could be more or less depending on other factors, including geography, age, and smoking status.
But it can get worse than that as a practical matter. Take a couple that expects to make $84,600. They’ll sign up in December and get a subsidy of $10,593 and merrily go through the year paying $599/month. When they file their taxes in April of the following year, they discover they accidentally made $84,601. They’ll be surprised to experience $10,593 extra hit to their taxes. They have to repay it in full.
In 2021, only 400,000 people earning more than 400 percent of FPL purchased ACA Exchange plans. Around 1.5 million did last year. The reason is obvious. It got a lot cheaper for them when the subsidy cliff was eliminated.
About half of the 1.5 million people are like me, early retirees between the ages of 50 and 64. Many of them still work a little bit or do some ad hoc consulting, for example. If you’re one of them, you’ll explore options for reducing your income unless your income is much greater than $85,000. The subsidy cliff is essentially a 100 percent tax on the first $11,000 earned over the FPL for that married couple.
Most early retirees take some care to consider health insurance costs until Medicare kicks in. It’s a critical factor to consider when you make the decision to step aside. Hits to the household budget of this magnitude will cause hundreds of thousands of people to take measures to deal with it. Some will return to the workforce just to obtain health insurance. Others will find a way to spend less, reducing travel, charitable giving, and other discretionary items in their budgets.
Those retirees most seriously impacted are folks on traditional Defined Benefit Pension Plans, like retired teachers and retirees who worked in public safety jobs. It’s quite normal for a couple of retired teachers to earn more than $85,000 per year. If they didn’t get a health insurance continuation benefit as part of an early retirement program, they’ll have some difficult decisions coming up.
There are some creative steps one can take to game the system a little bit. Some fortunate retirees who have significant Roth IRA accounts may choose to rely less on Traditional IRA income and replace it with Roth IRA income. Roth withdrawals are not considered “income” for purposes of health insurance subsidies.
If most of your income is from Traditional IRAs or investment income from stock sales in a brokerage account, you might decide it’s better to live on borrowed money (for instance, a home equity line of credit) until you’re eligible for Medicare. For example, a married couple earning $95,000 from an IRA might choose to only withdraw $29,187 from their IRA, and get a home equity line of credit to cover the remainder so your spending on “Other Stuff” is the same in either case. That would put them at 138 percent of FPL, and they would become eligible for Medicaid, essentially paying no premiums at all.
“Other Stuff” is just everything other than income tax, health insurance premiums, and interest expense. That would put them at 138 percent of FPL, and they would become eligible for Medicaid, essentially paying no premiums at all. They would save $18,000 in health insurance premiums. The first year, they would save $18,000 in health insurance premiums and they would pay no Federal Income Tax. That’s offset by interest expense of $3,000.
Each year going forward, they would have to borrow a little more to cover higher interest expense on higher outstanding loan amounts. At age 65, they would withdraw enough to pay back the loan while keeping their standard of living unchanged. That would increase both their taxes and their Medicare rates in that 65th year. But their IRA balance will be $33,000 higher, even after paying back the loan and paying those higher tax and premium amounts. They will save $50,000 in Premiums, offset by an additional $37,000 in tax and interest expense. But again, the important metric is the change in the IRA balance. That $33,000 is equal to 61 percent of what they would have had to pay for health insurance. It’s as if they paid $595 per month for health insurance rather than $1,500.
The hack can be refined quite a bit by paying the loan back over a few years to avoid going into the higher tax bracket. Essentially, they would keep paying 7 percent interest on lower balances each year, but save 10 percent in taxes. The exercise implicitly assumes that general inflation and health care inflation are zero, which certainly won’t be the case. This is just a proof of concept.
While younger retirees are the cohort most impacted by the subsidy cliff, they’re not alone. Small businesses are another significant group. Small businesses and the self-employed are able to deduct health insurance premiums, so the impact of the change is less dramatic, but can still be quite significant. In some cases, they can employ a similar hack by using business debt rather than personal debt, in which case the interest expense is also deductible. But it would be difficult to impoverish oneself if one is taking a salary or realizing annual net income, whether distributed or not. In other cases, they may find it’s cheaper to get a small business group insurance plan to cover themselves and their employees rather than kicking them all to the exchanges.
The Congressional Budget Office estimates it would cost about $25 billion a year to fix the subsidy cliff, growing over time to about $335 billion over ten years. That’s obviously a significant impact on the deficit. Though tens of thousands of small businesses and retirees expecting a tax cut from Congress are going to get a little surly when they discover the higher premium costs will wipe out all of their tax savings, by several times in most cases.
One would tend to think that younger retirees and small business owners would be an influential constituency among Republicans in Congress. If they weren’t, Congress wouldn’t pander to them so routinely. And in Iowa, a good number of those small businesses are farmers. Around 1.5 million of them will see a material reduction in their living standards, face the prospect of being uninsured, return to the workforce if they can, or artificially impoverish themselves.
It would behoove affected consumers to explain to their elected representatives how seriously the ACA subsidy cliff will affect their financial well-being.
Top image is by Claudio Schwarz, available through Unsplash.