Balancing ROTH conversions & Healthcare subsidies

[walkinwood]

My income in ER will qualify me for healthcare subsidies.

A ROTH conversion will decreases current subsidies, but will also decrease RMDs.

There must be some ROTH conversion amount that optimizes RMDs in the future & subsidies today.

Any thoughts on this?

 

[47]

Without knowing tax brackets and subsidy cutoffs that are in the neighborhood of your situation, it is impossible to tell.

But my guess is a subsidy today is better and you can worry about your RMD when the time comes. This is especially true if you would be spanning subsidy thresholds because of the ROTH conversion.

If your RMD time is not too far off, your benefit in ROTH conversion is that much less anyway because of the time factor.

In any case, I would look to convert or not convert to ROTH for the tax treatment as a whole and not just for the RMD impact.

 

[brewer12345]

I have decided that in the first year out of the gate I will try to stay just a hair under 200% of the FPL (for the four of us that is about $47k). Why? If you are inside of 200% you not only get the subsidy but you get a richer plan via cost sharing, so the plans I see in silver (Kaiser) have no deductible, lower max OOP, and lower copays/coinsurance. If I have room under this level I will do roth conversions.

Given the wonky, cliff-ridden nature of this thing, I think the best way to manage it is to figure out where the cliffs are and pick your spot given your particulars. The obvious cliffs are the 100%/133% medicare/exchange line, the 200% line where you lose the cost sharing that results in a lot richer plan, and 400% where you lose all help. It would not surprise me if there were other cliffs.

 

[Dawg52]

It would not surprise me if there were other cliffs.

I'm looking for one now. One I can jump off and forget about all this crap.

 

[brewer12345]

I'm looking for one now. One I can jump off and forget about all this crap.

Its called medicare. You will go over that cliff whether you like it or not...

 

[walkinwood]

Thanks Brewer - good way to look at it. I was trying to create a spreadsheet & ended up in a most-non-ER state of mind.

 

[tinlizzy]

The Iowa Health and Wellness Plan aka expanded Medicaid, was designed to soften the effects of the cliffs. It's still waiting for Federal approval.

Adults under 100% will not go into Medicaid unless deemed medically frail. Instead they will be placed into (I've read a couple different versions) either a plan similar to the plan given to state employees or into the actual plan of state employees.

101% - 133% will enter a plan from the exchange (selected for them, I think, after a health assessment) and the expanded Medicaid money from the federal gov't will be used to pay all the costs associated with the plan.

They are hoping this will prevent "churning" in and out of Medicaid/traditional insurance because of changing income levels. Your insurance would stay the same but the amount you pay would change.

I'm thankful that none of this effects me yet!

 

[brewer12345]

Thanks Brewer - good way to look at it. I was trying to create a spreadsheet & ended up in a most-non-ER state of mind.

It does not pay to get worked up over this stuff. Treat it for what it is: another layer to the tax code. You did not get to ER by being foolish/ignorant of the tax code, so learn the latest twist and take advantage of what opportunities it offers.

For us, the 200% FPL is the absolute best trade-off due to the richer plan benefits it offers.

 

[Animorph]

As stated already, it all depends on your specific situation. For my own case, I found that the break even point for a tuition tax credit of $2500 was $40k of Roth conversions. If I was going to Roth convert instead of limiting my AGI to get the $2500 credit, I had to convert at least $40k more than the amount that brought me just to the income limit to make it worthwhile. It seems like a much larger ACA subsidy would be a pretty tough hurdle to jump for Roth conversions.

 

[clifp]

Maybe I am not thinking about this correctly but it seems to me you are better maximize your subsidy and forgetting the Roth conversion. For instance you the KFF calculator and California a 54 year increasing his income from 40,000 to 41,000 losing $95 in subsidy or 9.5%. Moving from 24,000 to 25,000 decrease his subsidy buy $142. For a 54 year old couple the income from 30K to 31K decreases the subsidy by $162.

The best case for the Roth is paying 15% tax bracket today to avoid a 25% tax bracket many years in the future, I supposed conceivable it might be 28% taxes at age 70.5 if you take you SS late and have a pension at 65.

But I personally would rather have a 9.5% return today (worse case) than perhaps a 13% return a decade or more in the future.

 

[pb4uski]

Interesting angle clifp. If I limit my income to $31,190 I get a $700 per month subsidy. If I limit my income to $61,190 I get a $341/month subsidy. So the reduction in subsidy for a year is ~14% of the increase in income so perhaps paying an 25% on RMDs later in life isn't so bad after all.

In reality though, I've got additional complications of state income taxes and changes in property tax relief benefits to consider.

 

[ziggy29]

Given the wonky, cliff-ridden nature of this thing, I think the best way to manage it is to figure out where the cliffs are and pick your spot given your particulars. The obvious cliffs are the 100%/133% medicare/exchange line, the 200% line where you lose the cost sharing that results in a lot richer plan, and 400% where you lose all help. It would not surprise me if there were other cliffs.

If someone is an American Indian, there is also a huge cliff at 300% where you lose the exemption from *all* cost sharing. That's the one I need to stay under.

 

[walkinwood]

Maybe I am not thinking about this correctly but it seems to me you are better maximize your subsidy and forgetting the Roth conversion. For instance you the KFF calculator and California a 54 year increasing his income from 40,000 to 41,000 losing $95 in subsidy or 9.5%. Moving from 24,000 to 25,000 decrease his subsidy buy $142. For a 54 year old couple the income from 30K to 31K decreases the subsidy by $162.

The best case for the Roth is paying 15% tax bracket today to avoid a 25% tax bracket many years in the future, I supposed conceivable it might be 28% taxes at age 70.5 if you take you SS late and have a pension at 65.

But I personally would rather have a 9.5% return today (worse case) than perhaps a 13% return a decade or more in the future.

Thank you. Another great way to look at this.

I did some simplistic calculation assuming a 2.5% real return in the IRA. If the same 54 year old earning $40000 had left that additional $1000 in the IRA, it would lead to an increase in RMD at age 70.5 of about $59!

So $95 in rebates today v/s an additional $59 in RMD income at 70 1/2. Even with the SS & medicare related cliffs at 70.5, taking the subsidy now is probably better than worrying about RMDs - as you said.

(This was a quick calculation, so please redo if you're going to base your decisions on it)

 

[brewer12345]

Thank you. Another great way to look at this.

I did some simplistic calculation assuming a 2.5% real return in the IRA. If the same 54 year old earning $40000 had left that additional $1000 in the IRA, it would lead to an increase in RMD at age 70.5 of about $59!

So $95 in rebates today v/s an additional $59 in RMD income at 70 1/2. Even with the SS & medicare related cliffs at 70.5, taking the subsidy now is probably better than worrying about RMDs - as you said.

(This was a quick calculation, so please redo if you're going to base your decisions on it)

Looks like I am going to have to do a bunch of spreadsheeting before I do anything next year. I will want to stay above the line where I would get tossed into Medicare and any taxable cap gains I feel the need to take and can get a 0% LTCG rate on are worth doing. Roth conversions will need some heavy spreadsheeting to figure out if they are worth it.

 

[daylatedollarshort]

We are getting the Bronze HSA plan. The subsidized premium does not go up much from 100% FPL to 400% FPL, and what we do pay is a tax deductible business expense.

Most years we usually incur around $3K total in medical expenses. We use Chinese medicine for most of the day to day stuff so normally we only have a few medical bills each year for things like a broken bone or strep throat.

If we took the silver plan we'd have to pay several thousand a year in premiums alone even at a low income level. If we had a high medical expense year, the out of pocket max is the same whether we have the Bronze or Silver plan, but with the silver we'd pay as much as an extra $6K in premiums, if we had income closer to 400% of FPL.

So we pretty much come out ahead with the Bronze plan under most likely scenarios. Plus the Bronze premiums are so low after tax that even if we go toward 400% of FPL to do Roth conversions or have extra AGI from the businesses, we don't lose much in subsidies.

 

[Chuckanut]

To make matters more interesting, my current plan non-exchange plan is about 50% more costly than a subsidized Gold plan, but the deductible and stop loss limits are far less. So, the question is "Do I feel lucky?" An MRI or two, or one quick visit to for a minor outpatient surgery would wipe out a year or two of premium savings.

 

[pb4uski]

Looks like I am going to have to do a bunch of spreadsheeting before I do anything next year. I will want to stay above the line where I would get tossed into Medicare and any taxable cap gains I feel the need to take and can get a 0% LTCG rate on are worth doing. Roth conversions will need some heavy spreadsheeting to figure out if they are worth it.

Let me know how you come out because I'm facing a similar situation. for now I have decided to focus on 0% capital gains rather than Roth conversions. For 2013, I'll limit my income to the cliff for our state's property tax relief since on the next 10k my total marginal rate is 26% and the marginal rate to the top of the 15% bracket is ~20%. At that rate, I have a few years of capital gains to harvest before I would start Roth conversions.

I'll admit to sometimes wondering if I should be prioritizing 0% capital gains over Roth conversions, but 0% is hard to resist.

 

[sengsational]

It does not pay to get worked up over this stuff. Treat it for what it is: another layer to the tax code. You did not get to ER by being foolish/ignorant of the tax code, so learn the latest twist and take advantage of what opportunities it offers.

For us, the 200% FPL is the absolute best trade-off due to the richer plan benefits it offers.

Yep, just another layer of rules to navigate.

I suspect that you and yours have some expected annual health care bills, so you "know" that the zero copay benefit of being 200% FPL will be exercised. In my case, I've been in an HRA for the last 5 years where megacorp put in $2k per year. We had a hard time spending it! I got a few scans I could have lived without, but even so, we still have a hefty balance. So for me, it's not so clear that I'd benefit that much from being at 200% vs 400%. But you have given me something to think about!

 

[Options]

Let me know how you come out because I'm facing a similar situation. for now I have decided to focus on 0% capital gains rather than Roth conversions. For 2013, I'll limit my income to the cliff for our state's property tax relief since on the next 10k my total marginal rate is 26% and the marginal rate to the top of the 15% bracket is ~20%. At that rate, I have a few years of capital gains to harvest before I would start Roth conversions.

I'll admit to sometimes wondering if I should be prioritizing 0% capital gains over Roth conversions, but 0% is hard to resist.

If you've not been contributing to any retirement accounts in the last year, shouldn't all of your gains be LTGC's? Or are you doing something else?

 

[pb4uski]

If you've not been contributing to any retirement accounts in the last year, shouldn't all of your gains be LTGC's? Or are you doing something else?

Not yet. As a result of some rebalancing that I did on Dec 12, 2012 I have a lot of gains that are currently short-term and all my taxable holdings will be long-term on Dec 13, 2013. It's a bit of a long story but to crystalize some gains at 0% last year I sold some Total Stock and simultaneously bought proportions of S&P 500, Mid-Cap Index and Small-Cap Index that together are the same as Total Stock. It was a way of getting around Vanguard's frequent trading restrictions while not missing a day of market performance. I didn't want to be out of the market a day and have it happen go up 1% that day.

Contributions to retirement accounts wouldn't have an effect since all my retirement account withdrawals will be ordinary income since the contributions were all pre-tax money or deductible contributions.

 

[walkinwood]

Oh boy! Forgot about the 0% cap gains bracket.

Here's my thinking - please flag if I've made a mistake.

Max long term cap gains are 15%. So, by taking an additional $1000 in LT Cap gains in the 0% CG tax bracket, you potentially save a max of $150

Here are the annual subsidies for different income levels for a family of 2 (From the Kaiser Foundation calculator): The third column shows how much subsidy you lose for every $1000 in AGI gain.

AGI|Subsidy|Decrease
$28,000|$7,483|
$29,000|$7,343|$140.00
$30,000|$7,197|$146.00
$31,000|$7,045|$152.00
$32,000|$6,909|$136.00
$33,000|$6,770|$139.00
$34,000|$6,626|$144.00
$35,000|$6,477|$149.00
$36,000|$6,324|$153.00
$37,000|$6,166|$158.00
$38,000|$6,004|$162.00
$39,000|$5,840|$164.00
$40,000|$5,685|$155.00
$41,000|$5,525|$160.00
$42,000|$5,362|$163.00
$43,000|$5,195|$167.00
$44,000|$5,024|$171.00
$45,000|$4,850|$174.00

So, depending on your family size & AGI, for every $1 increase, you could be losing more in subsidies than the max cap gains tax.

There probably are other tax related cliffs that come into play here, but that's beyond my ability to figure out.

 

[Options]

Not yet. As a result of some rebalancing that I did on Dec 12, 2012 I have a lot of gains that are currently short-term and all my taxable holdings will be long-term on Dec 13, 2013. It's a bit of a long story but to crystalize some gains at 0% last year I sold some Total Stock and simultaneously bought proportions of S&P 500, Mid-Cap Index and Small-Cap Index that together are the same as Total Stock. It was a way of getting around Vanguard's frequent trading restrictions while not missing a day of market performance. I didn't want to be out of the market a day and have it happen go up 1% that day.

Contributions to retirement accounts wouldn't have an effect since all my retirement account withdrawals will be ordinary income since the contributions were all pre-tax money or deductible contributions.

Thanks for the clarification. I'll be doing something similar because next year (last year before FIRE) I have some rather screwy financial movements I have to accomplish. After that, year 2016 will be all LTCG's for me.

 

[tinlizzy]

What's considered last minute for a Roth conversion? I'm assuming Dec.31 for the tax year?

Last year for me ended with a $5,000 special dividend in December. I know the special dividends were because of the potential change in the tax code and not typical, but they did come to mind, and could potentially throw a single person head first over a cliff forcing them to recharacterize a Roth conversion if done too early.

 

[Live And Learn]

How do we know what RMD laws will look like when we're 70 ? My vote is to go for the 'known' and go for the subsidies until those laws change.

 

[Animorph]

What's considered last minute for a Roth conversion? I'm assuming Dec.31 for the tax year?

Last year for me ended with a $5,000 special dividend in December. I know the special dividends were because of the potential change in the tax code and not typical, but they did come to mind, and could potentially throw a single person head first over a cliff forcing them to recharacterize a Roth conversion if done too early.

Last minute is Dec. 31, but with the possibility to recharacterize until after Apr 15th the following year there is no need to Roth convert that late. You should most likely convert early (and as needed thereafter) and into multiple accounts. The goal is to convert the target shares at the lowest price of the year. Then when you do your taxes and determine exactly how much you can safely convert, select your most beneficial conversion accounts (worth much more than you converted at would be nice) that fit within that total conversion amount and recharacterize the rest. Just be sure to read the rules. You can recharacterize a portion of one Roth account, but with multiple accounts you will know exactly what you are getting and have your choice of which accounts to recharacterize. There have been one or two threads discussing Roth conversion strategies.