ACA cliff suspension strategy

[Finance Dave]

Given the two-year suspension of the cliff, I'm thinking of doing the below...thoughts?

We have been managing MAGI to stay under the cap...successful so far. A few facts to help:
1) Most of our savings is in tax-deferred plans
2) We spend about $80-90k/year, and have income from PT w*rk and rental properties of about $40k, so we need another $45 or so from somewhere.
3) We have very little cash cushion, as we don't want to lose the large subsidy on HC by taking too much out of the TIRAs and increasing our MAGI.
4) I'm 60, DW 63
5) We have 5 paid-for rental properties, and would like to sell them off slowly over time. To make math easy, let's say we'd make a profit (on tax return) of about $70k on each one.

With this suspension, I'm thinking we do the following:
1) Take out $150k from one of our TIRAs in 2021. This would put us at $190k income, but take the $24k standard deduction and we're back in the 22% bracket, right?

2) Then we take $14k of that money and fund Roth IRAs for 2021. Then on January 1st we can use another $14k to fund our 2022 Roth IRAs. (I do have enough "earned" income from my PT w*rk to be able to do this...barely lol)

3) Any left over could be either put in our joint checking to live on, or we can invest it in a standard investment account (not a retirement account) and transfer as needed to checking for living costs. We would likely invest this very conservatively or build a CD ladder or something.

2) In 2022, sell one or two rentals. If we sold 2, our income would be $140k plus $40 from work/rents for a total of $180k...and by the time you take off the $24k standard deduction we'd be in the 22% bracket, right?

Doing this for those two years would allow us to move a large chunk of our net worth to after-tax accounts, improve our liquidity, and minimize the impact on our subsidy.

Although I don't like the idea of jumping so heavily into the 22% bracket, I like the idea of losing the HC subsidy even less...it's about $15k/year for us. The one downside I see is losing the tax-deferred nature of gains on the large TIRA withdrawals, but we'd be taking that money out anyway slowly over the next 3-5 years to live on.

What am I missing or what other ideas do you have?

We do have Roth IRAs, but the balances are fairly modest (about $125k combined)....so we could use those each year to "manage" income also.

 

[SecondCor521]

Misc comments:

1. Assuming MFJ and 2022, the standard deduction is $25.9K and the top of the 22% bracket is $178,150. So you could have a gross income of $204,050 in 2022 and stay in the 22% bracket.

2. Some of the rental sales would be capital gains and some should be depreciation recapture. The point is that the taxation of those will be different from the 22% bracket - maybe more, maybe less depending on your situation.

3. If I were in your shoes, I'd simplify things by just doing a Roth conversion of $150K, then pull your spending from your Roth as needed. This way you maintain tax deferral on whatever you're not using, and you also can ignore Roth contribution limits (there is no dollar limit to Roth conversions). You could still do a CD ladder if you wanted inside either your Roth or traditional and have whatever liquidity you want inside the IRAs.

4. Personally I just look at the loss of ACA subsidy as a parallel tax. You can look at the second graph in this article to see what the marginal rate works out to be for whatever income range you happen to be at:

https://seattlecyclone.com/aca-premium-tax-credits-2021-edition/

So for me, for example, I'm evaluating an AGI which would put me at about 250% of FPL. Looking at the graphs at the above link, it shows me that in that area, it represents about a 14% additional marginal tax. I can then add that to my ordinary income tax rate and see what my marginal cost of income is. So if I'm in the 12% bracket, that would be 12% + 14% = 26%.

I compare that to what my tax situation looks like at 75. If my rate at 75 would be, say, 30%, then I'm happy to realize more income now. If my rate at 75 would be, say, 20%, I should try to avoid realizing that much income now.

HTH.

 

[RunningBum]

My misc comments, in addition to SecondCor's that all make sense to me.

1. Even though the cliff is gone, the amount of your subsidy is still based on MAGI. With 190K MAGI, you'll be expected to pay $16,150 toward health insurance on the SLCSP. You'll only get a subsidy of that SLCSP - $1346/month.

2. Funding your Roth IRAs--do you have wage income to do this? I don't believe rental income counts.

3. Use your tax program or an online tax calculator like https://www.irscalculators.com/tax-calculator to verify for yourself what bracket you are in.

4. You say

The one downside I see is losing the tax-deferred nature of gains on the large TIRA withdrawals,

This is not a downside. The benefit of your tIRA was deferring income, hopefully when you were in a higher bracket. Gains you make inside the tIRA will eventually be taxed at regular income rates. Once withdrawn to a taxable account, gains are taxed at the more favorable capital gains rate. So when tax rates are favorable, there's no downside to withdrawing from your tIRA. Converting to a Roth, where gains are never taxed, is even better.

 

[Surewhitey]

Our plan is to live off taxable accounts and do Roth conversions along the way until 65. We'll probably need 10 years worth to do this. I'll probably do an occasional j*b for locals for play money too. Keeping it simple and just above Medicaid...

Not there yet & hoping ACA is still a good option.

 

[bobandsherry]

The Build Back Better currently has provision to extend the cliff elimination through 2025. So something that you might want to consider in your planning. That would help me get much closer to the finish line for Medicare, and my plan is to top off at the 12% level this year. I'll look at next year and react based on what gets passed with the BBB. I'd rather not just pay 10% more on tax, so taking a gamble it's passed as honestly the cliff is just silly as it's currently written.


https://www.healthaffairs.org/do/10.1377/hblog20211029.871712/full/

 

[COcheesehead]

I played with my income numbers on the exchange. The amount of the premium credit doesn’t change all that dramatically with income increases. A few hundred difference a month. So I put in the high end of the range when applying. It all evens out at tax time anyway, both ways, up or down.

 

[skibum]

Income above the 400% of FPL incurs an 8.5% increase in health care costs as described, effectively a surtax. The marginal federal tax rate from 400% of FPL to the top of the 12% bracket is therefore 20.5%. I foresee future taxes into the 22% bracket (for us), worst case 24%, so withdrawing now at 20.5% marginal is just slightly favorable. I also have most assets in qualified plans I'd like to access for family expenses, so this is my target. Withdrawing or taking capital gains into the 22% bracket would incur a marginal rate of 30.2% with ACA surcharge, which is more than any future estimated tax rates (for us). In a few years when medicare kicks in and the ACA surtax is no longer applicable to us, the marginal tax rates for MFJ are expected to be 22% up to $178k taxable, and 24% up to $340k taxable. I therefore plan to wait a few years for the ACA surcharge to drop off before selling rental properties, incurring large capital gains, and taking tIRA withdrawals or Roth transfers into the 22%/24% bracket. I'd prefer to withdraw and convert more tIRA assets now, but with the 8.5% hit to healthcare costs, it seems more cost effective to wait than incur a 30% marginal tax rate now.

This has been noted, but to further clarify since my comment does not explicitly state the applicable income, ACA costs are based on MAGI, and fed tax rates are based on taxable income. Taxable income is AGI less standard or itemized deductions.

 

[SecondCor521]

I played with my income numbers on the exchange. The amount of the premium credit doesn’t change all that dramatically with income increases. A few hundred difference a month. So I put in the high end of the range when applying. It all evens out at tax time anyway, both ways, up or down.

True, with two notable caveats:

1. CSRs are not reconciled at tax time.

2. There are repayment limitations below 400% FPL.

Both of these incentivize taxpayers to estimate low.

 

[Finance Dave]

Misc comments:

1. Assuming MFJ and 2022, the standard deduction is $25.9K and the top of the 22% bracket is $178,150. So you could have a gross income of $204,050 in 2022 and stay in the 22% bracket.

2. Some of the rental sales would be capital gains and some should be depreciation recapture. The point is that the taxation of those will be different from the 22% bracket - maybe more, maybe less depending on your situation.

3. If I were in your shoes, I'd simplify things by just doing a Roth conversion of $150K, then pull your spending from your Roth as needed. This way you maintain tax deferral on whatever you're not using, and you also can ignore Roth contribution limits (there is no dollar limit to Roth conversions). You could still do a CD ladder if you wanted inside either your Roth or traditional and have whatever liquidity you want inside the IRAs.

4. Personally I just look at the loss of ACA subsidy as a parallel tax. You can look at the second graph in this article to see what the marginal rate works out to be for whatever income range you happen to be at:

https://seattlecyclone.com/aca-premium-tax-credits-2021-edition/

So for me, for example, I'm evaluating an AGI which would put me at about 250% of FPL. Looking at the graphs at the above link, it shows me that in that area, it represents about a 14% additional marginal tax. I can then add that to my ordinary income tax rate and see what my marginal cost of income is. So if I'm in the 12% bracket, that would be 12% + 14% = 26%.

I compare that to what my tax situation looks like at 75. If my rate at 75 would be, say, 30%, then I'm happy to realize more income now. If my rate at 75 would be, say, 20%, I should try to avoid realizing that much income now.

HTH.

These are great thoughts, thank you. My question on the Roth conversion is...do I need "earned income" of that amount? I have modest earned income of about $25k...so didn't think I could convert more than that.

That's a great way of thinking of the ACA "tax"...I'll do some thinking on that.

 

[Finance Dave]

My misc comments, in addition to SecondCor's that all make sense to me.

1. Even though the cliff is gone, the amount of your subsidy is still based on MAGI. With 190K MAGI, you'll be expected to pay $16,150 toward health insurance on the SLCSP. You'll only get a subsidy of that SLCSP - $1346/month.

2. Funding your Roth IRAs--do you have wage income to do this? I don't believe rental income counts.

3. Use your tax program or an online tax calculator like https://www.irscalculators.com/tax-calculator to verify for yourself what bracket you are in.

4. You say

This is not a downside. The benefit of your tIRA was deferring income, hopefully when you were in a higher bracket. Gains you make inside the tIRA will eventually be taxed at regular income rates. Once withdrawn to a taxable account, gains are taxed at the more favorable capital gains rate. So when tax rates are favorable, there's no downside to withdrawing from your tIRA. Converting to a Roth, where gains are never taxed, is even better.

More great points, thanks. Yes, I have about $25k of "earned" income...so we can contribute to a Roth...just don't know the rules on "conversions".

 

[Finance Dave]

Income above the 400% of FPL incurs an 8.5% increase in health care costs as described, effectively a surtax. The marginal federal tax rate from 400% of FPL to the top of the 12% bracket is therefore 20.5%. I foresee future taxes into the 22% bracket (for us), worst case 24%, so withdrawing now at 20.5% marginal is just slightly favorable. I also have most assets in qualified plans I'd like to access for family expenses, so this is my target. Withdrawing or taking capital gains into the 22% bracket would incur a marginal rate of 30.2% with ACA surcharge, which is more than any future estimated tax rates (for us). In a few years when medicare kicks in and the ACA surtax is no longer applicable to us, the marginal tax rates for MFJ are expected to be 22% up to $178k taxable, and 24% up to $340k taxable. I therefore plan to wait a few years for the ACA surcharge to drop off before selling rental properties, incurring large capital gains, and taking tIRA withdrawals or Roth transfers into the 22%/24% bracket. I'd prefer to withdraw and convert more tIRA assets now, but with the 8.5% hit to healthcare costs, it seems more cost effective to wait than incur a 30% marginal tax rate now.

This has been noted, but to further clarify since my comment does not explicitly state the applicable income, ACA costs are based on MAGI, and fed tax rates are based on taxable income. Taxable income is AGI less standard or itemized deductions.

Thank you for your thoughts. Some questions...

1) What info do you have about ACA surcharges "falling off" in the future? I'm not saying they don't...just saying I need to read up on this if you have a link.

2) Just a note that ideally we'd just withdraw up to the top of the 12% bracket...but we spend more than that each year...so at some point we have to get into the 22% bracket, even if only for 1-2 years. Depending on how the cap gains flows through from our rental sales, selling one unit may hold us over for 3-4 years. Our properties are all paid for (no mortgages), we have 5 of them, and they range in approx value from $85k to about $160k. The one we plan to sell in 2022 will list for about $145k. I don't have exact numbers, but I believe the basis will be around $60k...so we'd see a cap gains of about $85k. But the nice thing is that nearly all of the $145k (less any fix up costs and realtor fees) would go straight to our bank account where we can use it to live off.

3) can you clarify what the ACA surtax is that you mention that will go away when Medicare kicks in?

 

[SevenUp]

These are great thoughts, thank you. My question on the Roth conversion is...do I need "earned income" of that amount? I have modest earned income of about $25k...so didn't think I could convert more than that.

There is no limit on Roth conversion amounts.

There is a limit on annual contribution amounts but even that is unaffected by your conversion amounts.

 

[SevenUp]

More great points, thanks. Yes, I have about $25k of "earned" income...so we can contribute to a Roth...just don't know the rules on "conversions".

Thank you for your thoughts. Some questions...

1) What info do you have about ACA surcharges "falling off" in the future? I'm not saying they don't...just saying I need to read up on this if you have a link.

...

3) can you clarify what the ACA surtax is that you mention that will go away when Medicare kicks in?

Reading Roth IRA conversion - Bogleheads and Roth Conversion and Capital Gains On ACA Health Insurance might be worthwhile.

 

[skibum]

Thank you for your thoughts. Some questions...

1) What info do you have about ACA surcharges "falling off" in the future? I'm not saying they don't...just saying I need to read up on this if you have a link.

2) Just a note that ideally we'd just withdraw up to the top of the 12% bracket...but we spend more than that each year...so at some point we have to get into the 22% bracket, even if only for 1-2 years. Depending on how the cap gains flows through from our rental sales, selling one unit may hold us over for 3-4 years. Our properties are all paid for (no mortgages), we have 5 of them, and they range in approx value from $85k to about $160k. The one we plan to sell in 2022 will list for about $145k. I don't have exact numbers, but I believe the basis will be around $60k...so we'd see a cap gains of about $85k. But the nice thing is that nearly all of the $145k (less any fix up costs and realtor fees) would go straight to our bank account where we can use it to live off.

3) can you clarify what the ACA surtax is that you mention that will go away when Medicare kicks in?

I will start by saying the links provided by SevenUp are excellent to describe, quantify, and visualize the interaction of ACA subsidies, tIRA withdrawals, SS, etc.

The first case study in the article illustrates my description and plans (although I do not address taxes below 400% of FPL).

In response to your questions:
1) and 3): The ACA subsidy for 2021 and 2022 has been modified to remove the cliff at 400% of FPL. The "cliff" created some harsh outcomes from small changes and was not consistent with most tax incentives which phase in or out over a range of income. Rather than wipe out all subsidies at 400% of FPL, the subsidy ramps down at a rate such that a families health care premiums are capped at 8.5% of household income. This cap on health care premium costs therefore reduces the subsidy by 8.5% for every dollar above 400% of FPL. I've referred to this as a "surtax" for purposes of understanding the marginal tax rate as ACA subsidies fade out. Perhaps "surtax" has a negative connotation for what is a fairly reasonable approach to phasing out subsidies. Regarding my comments to wait for this surtax to "drop off" before increasing withdrawals, I am referring to a few years from now when we are eligible for Medicare and are no longer using ACA plans and subsidies for health insurance.

2) The second example in the case study article shows the marginal tax rate of LTCG interacting with ACA subsidies. The outcome is similarly affected as shown in the second chart, with 8.5% additional marginal tax rate as ACA subsidies ramp down with household income above 400% of FPL. The good news is the LTGC tax rate in the 12% bracket is zero, so the effective marginal tax rate is 8.5% in this bracket as the ACA subsidy phases out, increasing to 23.5% in the 22% bracket, the sum of 15% LTCG tax in the 22% bracket and the 8.5% ACA phase out. So, there is likely a benefit to defer large withdrawals or LTCGs to maximize health care subsidies until Medicare coverage is available. I think the subsidy phase out at 8.5% of household income is reasonable approach, and would not hesitate to withdraw tIRA funds or sell rental property as necessary to fund expenses and incur this subsidy reduction. There is a tax subsidy advantage to defer optional withdrawals and LTCGs until no longer eligible for ACA subsidies. The pre-tax tIRA income, unrecaptured depreciation, and LTCGs need to be settled sometime, make your best effort and enjoy.

 

[skibum]

I read the initial post again, OP estimates $40k of income, and additional $45k needed to meet expenses.

The first scenario in the article indicates a couple with $45k of pension and dividend income can withdraw another $60k from tIRA before the marginal tax rate increases to 30% in the 22% bracket. This is the top of the 12% bracket, $105k AGI, or $81K taxable after $24k std deduction.

OP should be able to withdraw $65k to the top of the 12% bracket (20.5% marginal rate after ACA subsidy reduction), which might support family expenses as described.

Taking the $85k LTCG on a rental sale would incur 8.5% tax on the first $60k (ACA only, 0% LTCG tax rate), then 23.5% on the next $25k as shown on the second scenario of the Finance Buff article. Not a bad hit at all to put the LTCGs from rental appreciation into the family budget.

The main point is to recognize the 8.5% ACA subsidy phase out, and that it might not be ideal to push withdrawals, conversions, and LTGCs to the top of the 22% bracket with an effective marginal rate of 30.5%.

Looking forward to potential tax rates with SS and RMDs, the taxation of SS adds a similar surtax of approximately 10% on non-SS income from about $21k to $62k. This is somewhat comparable to the 8.5% ACA hit, so any ACA surcharge now may have similar marginal rates in the future when taking SS. SS taxes are non-elective, and potentially unavoidable occurring in the lower range of taxable income though.

From Medicare eligibility to drawing SS is the best time to max out withdrawals, conversions, and LTCGs to the top of the 22% or 24% tax bracket if receiving ACA subsidies.

https://www.bogleheads.org/wiki/Taxation_of_Social_Security_benefits

 

[sengsational]

My approach was to get everything entered into tax software, then iterate on how much to pull out of pre-tax. Resulted in this (doesn't include eventual IRMAA impact). This does include giving back quite a bit of the PTC, because at the time I applied, I didn't know about the cliff removal.

 

[Finance Dave]

Reading Roth IRA conversion - Bogleheads and Roth Conversion and Capital Gains On ACA Health Insurance might be worthwhile.

Thank you.

 

[Finance Dave]

skibum you bring up an excellent point about LTCG being at zero rate (other than the 8.5% for the HC), but am I correct that they LTCG income cutoff is based on TAXABLE income rather than AGI/MAGI? your post is extremely helpful, and I have a meeting Friday with our tax preparer to do a mock up of some of these scenarios. Thank you.

 

[SevenUp]

My approach was to get everything entered into tax software, then iterate on how much to pull out of pre-tax. Resulted in this (doesn't include eventual IRMAA impact). This does include giving back quite a bit of the PTC, because at the time I applied, I didn't know about the cliff removal.

Did you generate the points in that chart "by hand" or with a Python script, or...?

 

[SecondCor521]

skibum you bring up an excellent point about LTCG being at zero rate (other than the 8.5% for the HC), but am I correct that they LTCG income cutoff is based on TAXABLE income rather than AGI/MAGI? your post is extremely helpful, and I have a meeting Friday with our tax preparer to do a mock up of some of these scenarios. Thank you.

Not skibum, but yeah, LTCG income cutoff is done based on taxable income, and it depends on how much ordinary income you have - LTCG stacks on top of ordinary income.

See here for a visualizer:

https://engaging-data.com/tax-brackets/

Also, note that you might pay state income taxes on that 0% federal LTCG. Many states (including mine) start with federal AGI and make little or no adjustment for LTCG.

 

[skibum]

I think Michael Kitces article from 2014 is an excellent summary of the mechanics of the 0% LTCG. The transition points and regular income tax rates have changed since then, but the principles and strategies still apply. This is also one of the best explanations of the double taxation, (30% at the time), that occurs as additional income displaces 0% capital gains. I suggest you read this until it sinks in, it took me awhile and I still struggle.

To your question:
LTCGs are 0% in the 12% income tax bracket, the cutoff is $81k taxable income in 2021 for MFJ, or $105k AGI before subtracting the $24k standard deduction.

It seems to me the 8.5% loss of subsidy will hit equally against LTCGs at 0% or income/withdrawal/conversions at a 12% rate while on ACA plans waiting for Medicare. So using either asset for family expenses in the interim is the same tax rate as can be expected for future withdrawals, with the additional 8.5% above 400% of FPL.

I would be inclined to sell the rental in 2022 as described, since you leverage $145k of funds toward family expenses with $85k of LTCGs. With leftover funds from 2022, you could likely withdraw/convert to the top of the 12% bracket ($65k on top of $40k income) and hopefully cover expenses for a few years. Then, accelerate withdrawals and rental sales from age 65 to SS/RMDs.

Rereading Kitces article again how other income displacing 0% LTCGs again can result in a double whammy on the marginal rate on the other income, you might be better off in the medicare years to max out LTCGs one year, and tIRA withdrawal/Roth conversion income in other years. I haven't thought this all the way thru, it may be a moot point as you increase taxable income up to the top of the 22% or 24% bracket, but it seems doing both in a given year may displace some of the 0% rate on LTGCs.


https://www.kitces.com/blog/underst...st-capital-gains-for-a-free-step-up-in-basis/

 

[GTFan]

True, with two notable caveats:

1. CSRs are not reconciled at tax time.

2. There are repayment limitations below 400% FPL.

Both of these incentivize taxpayers to estimate low.

And these two considerations are very important if going for Silver CSR plans, IMO. Huge difference in cost by estimating low, and no drawbacks that we've seen.

 

[sengsational]

Did you generate the points in that chart "by hand" or with a Python script, or...?

The folks that make the H&R Block tax software did all they could to prevent automation (don't let you select/copy/paste using the standard easy stuff), but they're up against me, and I didn't give-up!

I wrote a script in a tool called SikuliX which matches visually and interacts with the tax software UI. I created a loop where I jacked-up up the conversion amount, then printed the 1040, selected text and pasted to an Excel sheet. Each column in that sheet was an entire 1040, but all I needed was one row in that output. Slow, but sure. While this runs, the machine can't be used, so I just started it, and found something else to do for an hour

 

[SevenUp]

The folks that make the H&R Block tax software did all they could to prevent automation (don't let you select/copy/paste using the standard easy stuff), but they're up against me, and I didn't give-up!

I wrote a script in a tool called SikuliX which matches visually and interacts with the tax software UI. I created a loop where I jacked-up up the conversion amount, then printed the 1040, selected text and pasted to an Excel sheet. Each column in that sheet was an entire 1040, but all I needed was one row in that output. Slow, but sure. While this runs, the machine can't be used, so I just started it, and found something else to do for an hour

That's impressive on many fronts - well done!

Definitely has the advantage that the function evaluation (tax calculation) will be as accurate as the commercial tax software can be.

For those with simple enough situations (and less scripting knowledge!) the case study spreadsheet in Excel will generate similar charts "automatically".

 

[RetiredAt55.5]

True, with two notable caveats:

1. CSRs are not reconciled at tax time.

2. There are repayment limitations below 400% FPL.

Both of these incentivize taxpayers to estimate low.

And these two considerations are very important if going for Silver CSR plans, IMO. Huge difference in cost by estimating low, and no drawbacks that we've seen.

I had a hard enough time last year getting my state run exchange to accept my income estimate, and I wasn't even trying to get that low for CSR's to kick in.