Retiring early under ACA: An unexpected outcome for employers?

Bradley-JeffWith the recent release of state health exchange premium data, we are finally getting a meaningful look at what the Patient Protection and Affordable Care Act (ACA) means for early retirees.

One of the largest barriers to early retirement is health coverage. Indeed, before ACA, purchasing individual coverage could be very expensive and significantly limit coverage for any preexisting conditions. Under ACA, the coverage is less expensive because of the inclusion of a large pool of younger workers and the requirement that the highest premium in an exchange plan cannot be greater than three times the lowest premium.

Workforce planning may be more critical than ever under ACA
• Depending on existing post-retirement healthcare options, employees may begin retiring much earlier than expected.
This Columbia University study notes that as many as 940,000 workers in “job lock” may leave employment because of the availability of healthcare under ACA.
• Employers should consider the ramifications of an unexpected wave of early retirements in 2014 as it will be easy for early retirees to receive heavily subsidized health coverage under ACA.

Managing MAGI is the key
Many early retirees who plan carefully can receive federal tax subsidies toward their cost of health coverage under the exchanges. Federal subsidies are available under ACA as long as the retired family has a modified adjusted gross income (MAGI) under 400% of the federal poverty level (FPL). There is no means testing for the federal subsidies.

Consider a married couple, both aged 55, with an expected 2014 MAGI of $63,000. According to this calculator from the Kaiser Family Foundation, they can expect to pay $13,461 in premiums for a silver plan. Because they are expected to be at 406% of FPL they are not eligible to receive any federal tax credits to help pay the premium.

However, if this couple has a 2014 MAGI of $62,000, they would be expected to be just under the 400% FPL threshold and eligible for $7,571 in federal tax credits to help pay for the coverage. Thus, with a bit of careful tax planning, early retirees can become eligible for tax credits to pay for a significant portion of the cost of an exchange plan.

What does this mean for potential early retirees?
• Careful tax planning is important. Failure to do so could result in missed savings under ACA.
• Deferring Social Security until eligible for Medicare (age 65) should be considered. Even though some Social Security income may be exempt from federal income tax, all Social Security income is includable in MAGI.
• It may make sense to defer taking distributions from tax-qualified retirement accounts until age 65. Funds necessary for living expenses may be taken instead from tax-exempt distribution sources such as personal savings or Roth IRAs.
• Other tax strategies to minimize MAGI may be useful:
– Sell assets that result in capital losses first
– Before retiring, consider converting any tax-qualified retirement accounts to Roth accounts

Please note that none of this should be construed as tax advice. Participants should consult with their respective tax advisors on these issues.

What does this mean for employers?
• Workforce planning for 2014 and beyond may be critical, for reasons mentioned above
• For those employers that wish to encourage early retirements, consider setting up Health Reimbursement Accounts (HRAs) for potential early retirees.
– HRAs allow early retirees to use the (usually notional) employer contribution to purchase health insurance from the exchange or to pay for other qualifying medical expenses
– HRAs do not require coverage under a high-deductible health plan and may be used to pay insurance premiums
• Consider moving early retirees covered under an existing retiree medical program to the health insurance exchanges.
– Potentially lower cost (which is due to premium subsidization), as mentioned earlier
– Because early retirees have much control of how and when they receive pension and savings plan benefits, a planning process can be used to maximize the federal subsidies
– Private exchanges have call centers and other support that come at little or no cost to the plan sponsor