Today I have a guest post from personal finance enthusiast Dan Griffin. While Dan is not a practicing financial planner, he passed the CFP exam in 2010 and holds an Executive Certificate in Personal Financial Planning from Duke University as well as an MBA from the University of North Carolina. 

Dan shares his analysis of tradeoffs between optimizing current year health care costs vs. doing Roth IRA conversions with an eye on long-term tax planning.  You can find his new blog at MoneyAndSpreadsheets.com. (Dan has no financial relationship with Can I Retire Yet?.)

In the past, I’ve written extensively about how Premium Tax Credits (PTC) help reduce the cost you pay for health insurance premiums and the evolution of the Affordable Care Act (ACA) over time. Dave recently shared his experience as a single early retiree buying health insurance on the exchange.

Dan’s post highlights a few key aspects of planning that enhance the conversation:

• The tradeoffs between minimizing income for short-term health care saving vs. generating income as part of long-term tax planning (i.e. Roth conversions or tax-gain harvesting),
• Expanding the conversation on the “other” subsidy that impacts health care costs, Cost Sharing Reductions (CSR),
• Considering the impacts the size of your household and your state tax situation has on these decisions.

This is a mind numbingly complex topic with many layers. I appreciate Dan’s willingness to share his detailed analysis. Take it away Dan….

Optimize Healthcare Now vs. Taxes Later?

A key benefit of going from a high income to a lower income (in early retirement, sabbatical, or even perhaps after a job loss) is that you have the opportunity to take advantage of lower tax brackets.  One easy way to do that is with a “Roth Conversion” — converting money from a (pre-tax) 401k, 403b, or IRA to a (post-tax) Roth IRA. Anything converted is taxed (as income) at the time of conversion, but never again.

For example, in 2025, a married couple (filing a joint tax return) can have taxable income (after deductions) of $96,950 while only paying a 12% marginal rate. So it could  be a missed opportunity to not use up that full 12% bucket! Furthermore, long-term capital gains (LTCG) and qualified dividends are taxed at 0% up to approximately this same amount of income. 

Income over this amount will be taxed at 22% (and over $206k at 24%) and LTCGs will be taxed at 15%!

In the case study below, we will look at several levels of potentially generated income (via Roth conversions) to see how each step of income impacts: 

• Subsidies on premiums (via Premium Tax Credits), 
• Subsidies on out-of-pocket health care expenses (via Cost Sharing Reductions), and 
• Marginal/effective tax rates.  

We will also consider the long term benefits of doing the Roth Conversions now while tax rates are relatively low vs. saving those conversions for later.

General Assumptions

In this case study, we will explore strategies to optimize after-tax income and minimize healthcare costs utilizing tax and ACA rules for 2025 based on the following assumptions:

• Married couple, ages 47M/44F.  
• Married filing jointly
• Three dependents who each qualify for the full Child Tax Credit.
• No significant employment income in 2025; income will primarily come from taxable dividends and Roth conversions. 
• The couple does not want their dependents to be covered under Medicaid/CHIP.
• The family lives in the US state of Florida (no state income tax) and will rely on the ACA for health insurance coverage.
• Federal Poverty Level (FPL) for a family of five (in 2024) is $36,580.  This will most likely be adjusted upward by a few percent for 2025.  However, we will use the available 2024 number for this case study.
• Income (as measured by MAGI) will determine eligibility for premium subsidies as well as “Cost Sharing Reductions” (CSR).  CSRs can reduce the deductibles of some plans significantly.
• We will assume that the couple has $1M in a traditional IRA (likely rolled from the previous employer’s 401k plan).
• The couple also has unrealized gains in a taxable account.

ACA Plan Details

• For the case study, we’ll assume the family plans to choose an ACA Silver Plan.
• Premium subsidies are calculated based on income at a given FPL.  Subsidies will fade as the potential MAGI steps up at each interval.
• The ACA subsidy formula currently caps healthcare premiums at no higher than 8.5% of income regardless of income.  However, since we don’t know what will happen in the future, it may make sense to create higher income now and plan to create lower income later. The 8.5% cap is scheduled to expire after 2025 if no legislative action is taken.

Tax Assumptions

• 2025 Standard Deduction: $30,000 for married filing jointly
• Child Tax Credit: Three children, each eligible for a $2,000 credit
• Tax Brackets: We will use 2025 tax brackets (10%, 12%, 22%) to approximate federal income tax liabilities.  We will not calculate potential state or local income taxes for this case study (as FL does not have a state income tax.)

Choosing a Plan

If the couple went with the “benchmark” plan, the couple would have a net monthly cost of only $61 per month after subsidies!  However, there is more to consider than just price.  

For example, which medical networks accept which insurance plans?  Is your needed medication covered or not covered in various plans?  

For our case-study clients, the “benchmark” plan appears to be an unlikely choice (an HMO with a small network of providers). 

Screenshots below from healthsherpa.com:

Instead, we have chosen a more expensive plan — Blue Cross “Blue Care Silver” plan — which is ~$600 more per month than the benchmark plan — pricing at $674 per month, after subsidies (at the $70k MAGI level).

It is noteworthy that at this income level, Cost Sharing Reductions (CSRs) apply, making the deductible $0, with a $0 co-pay for doctors visits, $5 specialist visits, $25 generic drugs, and a $6100 Out of Pocket (OOP) max for the family.  Now that is a great plan!

Methodology

Our goal is to examine the tradeoff between optimizing ACA subsidies versus other tax planning objectives when we have the opportunity to engineer our income in early/semi-retirement years when there is little to no earned income.

For our base scenario, we will assume that the clients have $25k base income from taxable dividends and/or other small side income earned during the year.  For example, if the client were to convert $45k from the traditional IRA to Roth, the MAGI would be $70k ($25k investment income + $45k conversion).  The couple would then take the standard deduction ($30k in 2025) to have a taxable income of $40k.

Since $70k is 191% of the federal poverty level, the couple will receive roughly $2100 in a monthly ACA Premium Tax Credit (i.e. subsidy to lower health insurance premiums). Furthermore, they will also qualify for Cost Sharing Reductions which significantly reduce the deductibles. (Editor’s note: You can easily see the impact that additional income has on your Premium Tax Credit and thus your cost for health insurance premiums with this calculator from the Kaiser Family Foundation.)

As we move down the chart, we will step up in $10,000 increments all the way to $170,000. (Going much under $70k, puts the couple in Medicaid territory, and going much over $170k phases out the significant subsidies and into much higher tax brackets.)

At each step, we will analyze how changes in income affect health care subsidies, tax liability, and overall costs. This will help create a holistic picture of how different choices impact each of the factors we intend to measure.

Does Minimizing Taxes This Year Make Sense?

From a tax perspective, at the $70k MAGI level, the couple would have a taxable income of $40k ($70k minus $30k standard deduction), and would only owe $4923 in tax, minus $6000 in child credits.  In other words, they would get a tax refund of over $1000 and actually have a negative effective tax rate!  (Paying less than 0%!) 

However, there is a big negative to this strategy.  At this low end of the income spectrum, the couple will be converting less than 5% of their IRA each year to Roth, which may be too slow to achieve other goals.  In the future, looking back, they may also view it as a missed opportunity to convert that traditional IRA in extremely low tax brackets. 

This particular couple’s situation is advantageous due to the added benefit of no state income tax in FL.  If the couple later relocates, that may no longer be the case. 

The First Sweet Spot: Cost Sharing Reductions

In the tax planning world, we sometimes face situations of “cliffs” — where one dollar over a line costs the tax filer a substantial amount of money.  This is the case with Cost Sharing Reductions (CSR).  

CSR are a lesser talked about subsidy than Premium Tax Credits which also lower your health care costs.  This is because CSR are only available with Silver Level plans and at certain income levels, up to 250% of the Federal Poverty Level. CSR are a major benefit if you qualify for them because they lower your:

• Deductible,
• Copayments or coinsurance, AND
• Out-of-pocket maximum

In our example, if the couple is aiming to be able to take advantage of CSR, they must be very careful to not go over the line.  A few hundred dollars of unexpected income could cost them thousands!  (See Table 1)

As you can see in Table 1, with just a small increase in MAGI to $80k, the CSR for the deductible is impacted significantly — and as we step up through the tiers, the subsidies on the OOP max fade as well. 

That extra $5k-10k in income may literally cost the couple $5k in OOP healthcare costs! On the other hand, as we step up in income, the couple is able to convert more of their traditional IRA — perhaps on a path to convert it entirely in 10-15 years, depending on their goals, portfolio growth, and anticipated future tax rules. This, of course, is a large topic for discussion by itself!

Considering Larger Roth Conversions

Let’s assume the couple decides to generate a MAGI income of $170k during the year (last line in Table 2).  Similar to the scenario above, we will assume a $25k base from dividends and side income with $145k from Roth conversions.  At this income level, the couple would now be at 465% of the Federal Poverty Level and would only qualify for roughly $1000 in monthly premium subsidies.

The same healthcare plan would now be $1782/month after subsidy with a $8k deductible and $16k OOP max! However, the couple would be able to get $145k from pre-tax IRA into their post-tax Roth at a relatively low effective tax rate.

After the $6000 child credit, the couple would owe $17,013 net tax due. That’s an effective tax rate of 10.0%.  (However, at this income, they are pushing into the 22% marginal bracket.)

Incremental Steps in Income

Clearly the costs and benefits shift between the high and low scenarios. Let’s now look at how each of those move as we take $10k steps between $70k and $170k MAGI.

As we saw in our previous examples, every step up in income creates extra cost in premiums, because of the gradual loss of the subsidy. (The CSR benefits on deductibles and OOP Max fade away in the first few steps until they are completely eliminated.) Similarly, as income increases, the marginal tax rate increases as well. So we see the effective tax rate walk slowly from below 0% up to 10% in our chart.  

Let’s look again at those same income steps — this time focusing on the total of tax, healthcare premiums, and assumed “out of pocket” health care costs (Table 3). The tax and premiums are easy to quantify, but of course OOP costs vary year to year, even for the same person.  

For this example, let’s assume that the OOP for the given year is the deductible plus half of the difference between the deductible and the OOP Max. (That very well may be overkill for the typical family, but the pattern should hold true.) Then we will look at the sum of these three as it compares to MAGI.

As we can see in the chart, there is a gradual increase in total tax + healthcare costs starting at 14% of MAGI and stepping up to 30%.  However, there are some clear breakpoints, which I’ve highlighted in yellow above.  For example, from 70k to 80k, we jump significantly because of the loss of CSRs.  There is a similar jump between 90k and 100k as the CSR fully fades and the deductible jumps to the full $8000.   

Similarly, the next big jump is between 120k and 130k as any additional dollars the couple earns now falls into the 22% marginal tax bracket.

Potential Optimal MAGI breakpoints for this couple:

• At $70k, the couple has a net negative tax payment and benefits from impressive subsidies on the premium, deductibles, and OOP max. However, they have very little room to do their Roth conversion, and need to be very careful to not accidentally hit the sensitive “cliff” that would disqualify them from CSRs. Total healthcare + tax cost is about 14% of MAGI.
• At$ 90k, the couple still has an effective tax rate of <1%. They still get impressive subsidies on premiums and deductibles. They have $20k of extra room to do Roth conversions or perhaps take capital gains at 0%. The only negative here is that even at the 90k level, the couple would only be converting 65k per year to Roth. At that rate, it will still take a very long time to do a full conversion (if that is their ultimate goal). Total healthcare + tax cost is about 22% of MAGI.
• At $120k, the couple is maximizing the 12% tax bracket and still only paying a 3.6% effective tax rate. This level allows them to convert $95k to Roth. While some subsidies have been lost at this level, the resulting premiums are still relatively affordable ($1250/month). Total healthcare + tax cost is 26% of MAGI.
• At $170k, the couple is still receiving $1068/month in ACA subsidies for the premiums. They have now pushed well into the 22% marginal bracket and total healthcare + tax cost is 30% of MAGI.  The major benefit here is the substantial amount converted to Roth. If the couple plans to return to work or move to a state with a substantial income tax, this may be a smart move to push hard on conversions while in their current situation.

Conclusion:

Ultimately, the couple will have to decide how their goals fit into these potential break points. They would then logically want to fill that bucket as much as they can before hitting the next breakpoint.  

For example, if the couple decided that an MAGI of $100k was a good compromise on speed of Roth conversion and ACA subsidies, they should consider pushing just a little further to the $120k range. That extra $20k only cost them $5,500 in additional tax and lost subsidies, and kept their total costs as a percentage of MAGI relatively flat at 26%.

Conversely, it would not make sense to go just beyond a breakpoint.  For example, once the CSR is lost, the family should push up to the next breakpoint. There is no sense in paying the price (of subsidies lost) without also gaining the maximum benefit from that loss.  

Furthermore, if the couple is convinced that federal tax rates will be higher in the future, or if they plan to move to a state with a hefty state tax, perhaps it makes sense to push deep into the 22% bracket.  

What we realize by doing this exercise is that, instead of a “right” or optimal answer, there is a continuum — based on the couple’s individual plans, desires, and circumstances — that may sway the decision one way or the other. And of course, it is impossible to know what congress will do with the ACA or tax law in the future.

 The goal is to make the best decision given the known information:  

• Will the couple remain in FL (a no state income tax state) for the long term?  Do they believe FL will continue to be 0% tax?
• Will the couple return to work at some point — thus pushing their income back into higher brackets?
• Does the couple believe the federal tax rates for the lower brackets will rise or fall in the future?
• Does the couple want to be “done” with all of their Roth conversions in the coming decade — thus having a large bucket of after-tax money for their older years or to pass to heirs?

By thinking in the way we have outlined in this case study, they should be well suited to consider where they fall in this spectrum and make a well-informed choice.

Chris $.02

Thank you Dan for sharing your thoughtful and in depth analysis. I want to highlight a few key points.

Dan already gave us a lot to consider, so I will keep my input brief.

Exposing My Blind Spots

As noted in the introduction, I’ve written extensively about the ACA over the years. I’ve emphasized Premium Tax Credits in my prior writing as this is an important aspect of the law that impacts almost all early retirees buying insurance through the marketplace.

I’ve largely ignored Cost Sharing Reductions, because of the limited applicability. Qualifying requires:

• MAGI < 250% of FPL, and
• Choosing a Silver Level Plan.

Only recently have I begun looking more in depth at the considerable benefits of CSR as I work with early retiree clients and having recently read about Dave’s experience with using the ACA. This is truly a sweet spot for certain individuals that can take advantage. I appreciate Dan highlighting this.

Unknowns….

Dan did a nice job highlighting the many unknowns that make this analysis so challenging. They include, but are not limited to:

• Future tax rates. Many aspects of the current tax code are set to expire at the end of 2025, pending legislative action.
• The future of the ACA. This is a politically polarizing topic that leads to constant uncertainty. The 8.5% of MAGI cap on health insurance premium that Dan highlighted in this post is a provision of COVID era legislation and is scheduled to expire at the end of 2025 if no action is taken to extend it.
• Your actual health and healthcare costs. This will vary a lot among households and can change on a dime for any individual.

And Absolute Knowns

I would point out a few things we all absolutely do know. If you share a similar situation to Dan’s with kids still in your household, take note how having dependents living with you is very helpful with regards to creating income in a tax-efficient and ACA subsidy friendly manner. 

The child tax credit provides $2,000/per eligible child (under age 17). A $500/qualifying dependent credit is available for each dependent other than a qualifying child (i.e while still a dependent but age 17+).

Larger households also mean you qualify for larger subsidies at a given level of income. It is worth taking a closer look at the FPL tables for different household sizes to gain a better appreciation of this impact.

These benefits go away for everyone once kids age out. So it is worth considering the impact this has so you don’t miss out on this limited time window for tax planning.

Our kids aren’t the only ones aging. None of us is getting any younger!

Age is one of the few factors (along with tobacco use) insurance companies are allowed to use to charge higher premiums for an individual. Unsubsidized premiums will go up as you age.

Since health care premiums are capped at a percentage of your income, Premium Tax Credits become more valuable as you age. Plan accordingly!

Perspective on “Low Income”

The final key point I want to highlight in this post is the level of subsidies available at the higher end of Dan’s chart with the household with a MAGI of $170,000. In the post he writes:

“At this income level, the couple would now be at 465% of the Federal Poverty Level and would only (emphasis mine) qualify for roughly $1,000 in monthly premium subsidies.”

Take that in. At that income level, roughly double the median income for a household of this size in the state of Florida, they still qualify for a $12,000 annual subsidy!

Don’t automatically think ACA subsidies won’t benefit you because they are only for “lower income” tax payers. Many, if not most, early retirees can benefit from ACA subsidies to lower health insurance costs.

Take the time to run your own numbers and consider the planning implications.

Thanks again to Dan for sharing his thought process at this level of detail! Dan and I worked together on extensive edits to find the right level of detail to help without overwhelming readers. If you feel anything was omitted or unclear, assume it was an error on my part from the editing process and let’s talk about it in the comments.

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[Chris Mamula used principles of traditional retirement planning, combined with creative lifestyle design, to retire from a career as a physical therapist at age 41. After poor experiences with the financial industry early in his professional life, he educated himself on investing and tax planning. After achieving financial independence, Chris began writing about wealth building, DIY investing, financial planning, early retirement, and lifestyle design at Can I Retire Yet? He is also the primary author of the book Choose FI: Your Blueprint to Financial Independence. Chris also does financial planning with individuals and couples at Abundo Wealth, a low-cost, advice-only financial planning firm with the mission of making quality financial advice available to populations for whom it was previously inaccessible. Chris has been featured on MarketWatch, Morningstar, U.S. News & World Report, and Business Insider. He has spoken at events including the Bogleheads and the American Institute of Certified Public Accountants annual conferences. Blog inquiries can be sent to chris@caniretireyet.com. Financial planning inquiries can be sent to chris@abundowealth.com]

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