Case Study #1: ACA Insurance and Roth Conversions
In this case, we have a married couple who has just taken early retirement at age 55 with $1,000,000 in tax-deferred savings and $100,000 in regular (taxable) investments. They’ll have no income in retirement other than Social Security beginning at their full retirement ages of 67. They’ll buy an ACA health insurance policy with annual premiums of $10,000. The benchmark cost of an ACA Silver policy in their area is $7500, so they should quality for a subsidy as long as their AGI is within the qualifying limits. Their other expenses total $40,000, excluding income taxes.
They have two big questions:
We’re going to set up three scenarios in Pralana Gold to answer their questions. Scenario 1 is the baseline case where we specify the basic information described above using a withdrawal order of “regular then tax-deferred” to cover the negative cash flow. Scenario 2, which is based on Scenario 1, will answer their first question and Scenario 3, which is based on both of the other scenarios, will answer their third question.
Here are PRC’s projections for scenario 1. Total Savings at the end of their lives is $778,426 in today’s dollars.
You can see that they do not receive the ACA subsidy until their regular investment savings are depleted and they start taking withdrawals from tax-deferred savings which, in turn, gets their income into the qualifying range for the subsidies. They can probably do better than this by taking some action to increase their AGI to at least the Federal Poverty Level in the early years.
So we set up scenario 2 to investigate options for increasing their AGI. The first option considered is simply changing their withdrawal order to “tax-deferred then regular” and here are the results. This gets some small subsidies going but actually results in a final savings balance that’s worse than with scenario 1 because the rise in income taxes more than offsets the benefit of the subsidies.
Another option that Pralana Gold can model that may be the solution in this case is Substantially Equal Periodic Payments, or a SEPP. So we modify scenario 2 by reverting to the “regular then tax-deferred” withdrawal order and specify a SEPP to get just enough additional income to qualify for the subsidies. We set this SEPP to begin in the first year with annual payments of $17,000 for five years, and you can see below that this has the desired effect. But wait, we’ve got the subsidy for the first five years but have lost it for the next several years! SEPP’s can only run for five years or until you’re 59 and a half, so they lost that income boost and their AGI fell back below the Federal Poverty Level.
To attempt to resolve that issue they decide to change their withdrawal order to “tax-deferred then regular” starting in 2025 (PRC supports different withdrawal orders for three time periods) and you can see below that this takes care of the issue and the subsidies are back, and they get to a final savings balance of $828,634 for a much better long term solution.
Things are now moving in the right direction and we take the last step of investigating whether a Roth conversion might help even further. So, we set up scenario 3 by telling PRC to keep the SEPP and the withdrawal orders from scenario 2 and additionally model a conversion that begins in the first year and converts the maximum amount each year while staying in the 10% marginal tax bracket. Another parameter the user can specify is the percentage of the tax-deferred account to be converted, so the user investigates various settings and quickly determines that 20% yields the best long term result with a final savings balance of $829,687 in today’s dollars, but only about $1000 better than with scenario 2. All other parameter settings for the Roth conversion yield worse results. You can see in the screenshot below that this scenario slightly reduces the subsidy amount (by raising AGI), but it improves the long term result by reducing RMD’s and getting tax-free growth of the Roth account.
In the final analysis here’s a graphical comparison of the three scenarios which makes clear the right choice: buy the ACA health insurance policy, take a SEPP for the first five years, use a withdrawal order of “regular then tax-deferred” for the first five years and then “tax-deferred then regular” thereafter and forget the overhead of the Roth conversion.
Pralana Consulting LLC, Plano, TX
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