Update: As a result of the Tax Cuts and Jobs Act being signed into law, the tax code for 2018 has changed and the numbers cited below for standard deductions/personal exemptions will be different (the personal exemption of $4,150 is eliminated, but the standard deduction is doubled to ~$12,000). Your MAGI will increase or decrease slightly, but probably not too much. You can still use qualified retirement accounts (401k, Traditional IRA, etc…) and health savings accounts (HSAs) to reduce MAGI. This article will be updated once the IRS issues guidance on the new rules.
When I discuss Obamacare with people, the most common complaint I hear is that it’s too expensive. One middle-class family of three was paying $1,700 per month for a high-deductible insurance plan (which wasn’t actually on the exchange). Another claimed a “$30 per month plan was unaffordable” because her husband was out of work. Neither of these people had ever actually shopped for a plan on the exchange, because they just “wanted nothing to do with Obamacare”. Others report that their income is too high.
I was able to get the first family a plan for $236 per month. The second family would almost certainly qualify for free coverage through Medicaid, although they wanted nothing to do with it.
This article is addressed to people that “make too much money” to qualify for subsidies – you probably can – and to the people that say they can’t afford it because it’s too expensive.
Obamacare Subsidies and the Federal Poverty Line
The first thing you need to understand about Obamacare is how its subsidy structure works – everything is based off of the federal poverty line (FPL). The federal poverty line is based off of the number of people in your household (e.g. you, your spouse, and anyone you claim as dependents.) For example, if you file taxes as an individual, the federal poverty line for 2018, as it applies to you, is $12,060. If you are a family of three, your federal poverty line is $20,420.
|Persons in Household||100% FPL||138% FPL||250% FPL||400% FPL|
Obamacare works by subsidizing health insurance for consumers with a modified adjusted gross income (MAGI) up to four times the federal poverty line (400% FPL). A family of three with a MAGI of $80,000 per year will receive a discount of ~$1,700 per month off their health insurance. In my area, this family could buy a health insurance plan for as little as $236 per month. I do not think that is expensive to cover three people. If you make more than this or you tell me that it’s a high-deductible plan, then keep reading, I’ll get to you…
At the other end of the spectrum, a three person family with a modified adjusted gross income less than 138% of the federal poverty line – $28,179 per year – will pay nothing for their health insurance, assuming they live in one of the 33 states that chose to expand Medicaid. The person claiming “$30/Mo is too expensive” most likely qualifies for Medicaid, but because she refuses to go to the exchange for ideological reasons, she doesn’t have coverage. In states with expanded Medicaid coverage, there is no means testing – you can qualify based on income alone. See this page for more info on qualifying.
Finally, consumers with a modified adjusted gross income above 138% of the federal poverty line but below 250% – $51,050 for a family of three – will qualify for “extra savings”, which is an additional subsidy on silver plans to lower premiums and deductibles. As your modified adjusted gross income increases, the size of your subsidy decreases, meaning you pay more towards premiums and have higher deductibles. A family of three with a MAGI of $30,000 per year can get a silver plan for $20 per month with a $350 deductible and $1,200 out-of-pocket maximum. The same family on the same plan with a MAGI of $45,000 will pay $189 per month with a $4,500 deductible and $11,700 out-of-pocket maximum. They can also get a bronze plan for $4 per mo.
As you can see, Obamacare is structured to make health insurance affordable by having the government pay a portion of it, based on your income. The more you earn, the less the government pays towards your insurance.
Understanding the components of Modified Adjusted Gross Income (MAGI)
It’s important to understand that there are different deductions you can take to lower your modified adjusted gross income. Assuming you do not itemize your deductions, right off the bat you get to subtract $6,500 (or $9,550 for families) and a personal exemption of $4,150, from your income. Then you get to deduct things like alimony, student loan interest, retirement contributions, tuition costs, and health savings account contributions. Common deductions are listed on lines 23-35 on IRS form 1040.
Assuming you are paid a salary of $30,000 in 2018, your adjusted gross income might look something like this:
|Adjusted Gross Income||$18,550|
|Student Loan Interest||($800)|
If you entered $30,000 on healthcare.gov for a single individual in my area, your premiums would be $185 per month, with a $2,250 deductible and a $5,850 out-of-pocket maximum.
If you entered $18,550, your plan would cost far less – $48 per month with a $750 deductible and $1,450 out-of-pocket maximum.
To someone that makes $30,000 per year BEFORE TAXES, $185 per month for a plan with high deductibles seems expensive. But the plan for $48 per month seems reasonable, at least in my opinion. It should seem extremely reasonable if you’ve ever owned an insurance plan prior to Obamacare becoming law.
The larger point I’m trying to make is that the more deductions you take, the lower your healthcare costs will be. If you are a family of three making $82,000, you should throw $400 into an IRA, because this will lower your income below 400% of FPL, qualifying you for subsidies, and saving you about $1,700 per month in insurance costs. If the $30k salary person above contributes another $1,908 towards a retirement account, they will be under 138% of the federal poverty line, which qualifies them for Medicaid. So their choice is to pay $48 per month in premiums, or invest $159 per month into an asset they’ll get to withdraw in retirement. Nearly anyone can open an IRA, including young people.
If you’re self-employed, you can leverage a lot of options to lower your income. For example, a person earning $100,000 can contribute ~$8,400 to an SEP IRA and $5,500 ($6,500 if you’re over 50) for a traditional IRA, lowering your income by $13,900. Certain plans with high deductibles qualify for health-savings accounts, in which you can shelter an additional $2,700 per family. These deductions would put a family of three making $116,000 below 400% of the federal poverty line, qualifying them for subsidies.
|ADJUSTED GROSS INCOME||$80,750|
|Standard Deduction (Family)||($9,550)|
|Personal Exemption ($4,150 x 2)||($8,300)|
|Student Loan Interest||($800)|
|SEP IRA Contribution||($8,400)|
|Traditional IRA Contribution||($5,500)|
Furthermore, each person earning income can make these contributions. So if both you and your spouse work for employers offering 401k accounts, you can each contribute up to $18,500 ($37,000 total) and reduce the amount from your taxable income.
Is this complicated? Yes. Is it worth it? Absolutely. You get health insurance in case anything happens, and you’re putting away a substantial amount of money towards your retirement (you get to keep all those contributions). By not doing this, you pay the full unsubsidized price for your health insurance, which costs an extra $20,400/year, instead of saving $19,400/year. This is a net gain of nearly $40,000.
Setting up a SEP IRA (or one of the many other types of retirement accounts) is not necessarily straightforward, so you should get someone qualified to help you. Roth IRAs are after-tax money, so anything you put in there will not lower your adjusted gross income.
For a full list of what you can deduct, see the deductions page on healthcare.gov.
If you do it correctly, I do not think Obamacare is unaffordable. Is it expensive? Yes, but then again, so is our healthcare system. I had a routine surgery a year and a half ago. I walked in at 7AM and was out by noon. The bill was $21,500. My responsibility? $50. We don’t see a lot of the costs of our medical system because they are absorbed by insurance, but it is far more to deliver healthcare in the US than in other parts of the world (for various reasons that have nothing to do with Obamacare). Somebody is paying that tab, and the fact that it even costs $21,500 for a few hours in the operating room is insane.
While this tax jargon crap may seem complicated and unwieldly (and I agree that it is), it is worth it to get affordable coverage.
What if I don’t know what my income is going to be?
You need to have some sort of estimate. When you sign up for health insurance, the government will pay an amount based on this estimate to your health insurer. If you have an adjusted gross income higher than this estimate at the end of the year, you will need to pay back the difference on your tax return. If you estimated your income too low, you will receive the difference back. The amount you are required to pay back is listed on the IRS website. You will use IRS form 8962 to reconcile the amount of subsidies you are entitled to at the end of the year.
If your income is more than 400% of the federal poverty line, you need to pay your entire premium back, so it’s important to stay below that number. You do not want to get hit with a tax bill for $20,000. Do whatever it takes (legally) to reduce your MAGI below 400% FPL.
If your income is less than 100% of the federal poverty line, you will also need to pay your entire premium back, so make sure you do not go below that amount (Medicaid recipients don’t have premiums, so this doesn’t apply to them). You can take money out of a retirement account (you will need to pay income taxes and penalties on it), but it’ll count towards income to get you above the threshold.
If you are self-employed and really aren’t sure what you’re going to make, I’d suggest putting in a lower amount and staying on top of your books, so you’ll know what you’ll owe when tax time comes. Or, you can estimate a higher income and get money back. It depends on the type of person you are, but either way it will be a good time to learn an accounting system like QuickBooks, or to hire a bookkeeper/accountant to keep you apprised on your financial standing (this is a business expense, which will also lower your adjusted gross income). It may also help you decide when it’s appropriate to make financial business decisions – for example, in order to keep yourself under the 400% FPL, you might decide it’s better to hire someone to do some of your tasks, rather than pay an extra $20k in insurance costs. Bookkeepers are usually around $30-60/hr, and accountants can cost between $75-150/hr. Accountants can usually train you to use QuickBooks (mine charged me something like $75, and set up my accounts for me).
What if I lose my job/income?
Obamacare subsidies are based on your annual income, while Medicaid is based on your monthly income. If you lose your job in March and your three-person family’s income drops to $2,300 per month, you and your family can apply for Medicaid and be covered until you get another job. If you were receiving coverage through your employer, you are covered retroactively for 60 days from the time you leave your job through COBRA. So if you quit, get hit by a car, and need to go to the emergency room, you can buy COBRA up to 60 days AFTER you leave your job, and it will apply retroactively. You will need to pay the full amount (the employee + employer portions, which can hundreds or thousands of dollars), as well as any deductibles, but that is better than a $60,000 emergency room bill.
The Medicaid advice only applies if you live in one of the 33 states that expanded Medicaid. If your state did not expand Medicaid, I’m not sure what your options are (I suggest you start by calling the number on healthcare.gov).
If you lose coverage from work, get married, have a kid, or some other life qualifying event, you’ll be eligible for a special enrollment period to purchase coverage outside of open enrollment. You must apply for coverage within 60 days of the qualifying event.
What if I earn more money than I estimated?
You will need to pay the difference back. If you earn more than 400% FPL or less than 100% FPL by the end of the year, you will to pay the entire amount back, so don’t get caught in that situation.
You have until April 15th the following year to make IRA and SEP IRA contributions, so if you find that you are $5,000 over the 400% FPL limit, contribute $5,000 before April 15th and you should be OK. Other deductions are required to be paid in the year they are deducted, so this should be incentive to get your financial situation under control well before December 31, giving you time to make any necessary adjustments.
Explain Health Savings Accounts (HSAs) to me
Health Savings Accounts (HSAs) allow you to put money into a tax-free savings account. For example, if your adjusted gross income (AGI) is $30,000 and you put $1,000 into an HSA, your AGI is now $29,000. There are certain stipulations for HSAs – you must have a plan with a deductible over a certain amount and an out-of-pocket maximum below a certain amount, but in these circumstances, they work well. I believe (but am not entirely sure) you are also allowed to put money into an HSA and immediately withdraw it to pay medical expenses. So if you have a plan with a $4,000 deductible and need to go to the emergency room, you can put money into your HSA and then pay it from there. The contribution to your HSA will lower your AGI, which may result in you getting more money back at the end of the year, because your AGI will be lower than what you first reported, qualifying you for more subsidies.
You keep any money you contribute to an HSA, it rolls over from year-to-year, and you can invest it to grow (it works like a retirement account, for health-related expenses). This is a good solution for high-deductible plans, although some of the out-of-pocket maximums are too high to qualify. You should evaluate whether it is better for you and your family to select an HSA-eligible plan with lower premiums and higher deductibles, or higher premiums and lower deductibles, based on your estimated healthcare needs.
There are other types of HSA-like plans available, but you’ll need to do your own research because I’m not too familiar with them.
What else can I do to lower my MAGI?
If you work for a small employer that does not provide health insurance, or provides insurance through the exchange, ask them to look into setting up 401k plans for their employees. Even if it offers no employer-matching component, the 2018 contribution limit is $18,500, so you could earn quite a bit above 400% FPL, and put money away to bring it down below that amount. If both you and your spouse work, you can each contribute up to $18,500 of earnings per person to an 401k ($24,000 if you’re over 50). Using only the standard deduction, personal exemption, and 401k, a family of two can earn up to $120,170 and still qualify for subsidies. If you have additional deductions, you can earn even more.
If you earn below 250% FPL, there is a huge advantage to putting as much into retirement accounts as possible. Ideally, you want to offset whatever you are spending on premiums by redirecting them to your retirement account, because anything that goes into your retirement account is yours to keep.
Unlike an IRA, 401k contributions need to come directly from your paycheck, and need to be funded in year they are deducted (you only have until Dec 31 to make these contributions, not April 15). Make sure you know where you stand financially well before the year ends, so you have time to make adjustments if necessary.
There are other retirement accounts you may want to investigate here (though not all of these are tax-deductible).
If you have a really high income, you should meet with a tax specialist and figure out how to get your income below 400% FPL. For example, if you own rental property, one option might be to take out a home equity loan on your rental properties, which will increase your mortgage interest deduction expense. Then you can invest that money into something that is not taxed as regular income – for example, a growth ETF will only be taxed when you sell it and realize any gains. Doing so may have unintended consequences (high-risk investments may not be appropriate for people needing to cash out in less than 10 years, for example). Getting a good financial planner that can answer these questions for you will be key to figuring this out.
I don’t understand “premiums”, “coinsurance”, “deductible”, “out-of-pocket maximum”, and other insurance jargon…
Check out the glossary on healthcare.gov. The link is in the footer if you ever need to find it later. This does a good job explaining different terms with examples. I also suggest calling the phone number listed on healthcare.gov and speaking with someone if you have questions.
Where can I get more information?
How does Modified Adjusted Gross Income (MAGI) differ from Adjusted Gross Income (AGI)?
MAGI is AGI, plus a few deductions added back in. For many people, MAGI is the same as AGI.
What else should I know?
- On December 22, 2017, the Republicans passed the Tax Cuts and Jobs Act, which affects all of the numbers cited in this article for 2018 tax returns. The TCJA eliminates the personal exemption, but doubles the standard deduction, so most people’s adjusted gross incomes will change slightly. I will update this article once the IRS issues new guidelines regarding the new law.
- To shop for plans and pricing without creating an account, check out this link.
- You need to actually purchase a plan on the exchange to qualify for subsidies. If you buy an insurance plan outside of the exchange, you do not get any subsidies.
- Your household income includes income from your spouse as well as your claimed dependents. If you have kids that earn more than the standard deduction, make sure you factor this into your financial plan. If you’re really close to the 400% FPL, you might be able to gift them up to $5,500 and have them put it into an IRA, wiping out their net income for the year. (Gifts up to $14k are not taxable to the recipient.)
- I am not an accountant. This information is provided as-is and without any warranties. While I feel this information is well-researched and correct (it is the research I have accumulated to get health insurance for myself), I take no responsibility for any omissions or errors, or problems that may arise from using this information. If you have any questions, I highly recommend you seek financial advice from a qualified tax accountant.
Leave a comment in the comments section, and I’ll help you if I know the answer.