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Most older adults and retirees would agree that health care is near the top of their list of concerns. It’s not just the uncertainty of facing a medical condition or the associated costs. The sheer complexity of the American health care system also keeps many people up at night.
About six in ten adults surveyed by the Kaiser Family Foundation (KFF) said they were either “very” or “somewhat” worried about being able to afford the cost of health care services (1). Meanwhile, another survey from the same foundation found that many adults struggle to navigate the “complex labyrinth” of the country’s many parallel public and private medical insurance systems (2).
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It’s easy to feel lost, especially if you plan to retire before you become eligible for Medicare at age 65. However, the system becomes much clearer when you start focusing on the one key number the government uses to determine your monthly premiums.
That number is your household’s modified adjusted gross income (MAGI). If you understand this metric, it becomes much easier to make informed decisions with confidence. Medicare doesn’t come into play until later, making MAGI the critical factor for retirees in their 50s and early 60s.
Under the Affordable Care Act (ACA), the subsidies that help pay your premiums are calculated almost entirely based on your MAGI, not the cash you actually have coming in or your spending (3).
That distinction is critical.
You could be living on six figures in retirement, but if you optimize MAGI, you could significantly lower your healthcare premiums. In fact, with strategic planning, you can potentially even lower your monthly costs to $0.
That’s because MAGI doesn’t include all sources of income. For tax purposes, your household’s MAGI includes wages, interest, capital gains and withdrawals from traditional pre-tax retirement accounts. But other sources of cash, such as savings, the cost basis for investments, interest on tax-free securities, gifts and withdrawals from Roth IRAs, do not count toward MAGI (3) .
Strategically pulling money from a combination of all these sources can help you keep a lid on MAGI without compromising on your lifestyle.
To understand how MAGI optimization can make a big difference to your health care costs, consider the example of an older couple who need $100,000 a year to live in Los Angeles, Calif. Both are retiring at the age of 60, which means they do not yet qualify for Medicare.
The traditional approach would be simple, but costly. Withdrawing $100,000 from 401(k) and IRA accounts would result in a MAGI of $100,000. Based on the KFF’s Subsidy Calculator, this couple’s monthly premium for a bronze plan on the health care marketplace would be $356. For a silver plan, their monthly cost would be $708 (4).
Over the course of five years, this couple would spend a total of $42,480 on silver health care premiums alone.
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Now let’s compare this to a more strategic approach. The couple decides to take only $50,000 in income from their 401(k) and traditional IRAs. The other $50,000 is extracted from cash savings, Roth IRA withdrawals and interest on tax-free securities.
With a household MAGI of just $50,000, this couple can now benefit from much higher subsidies. According to the KFF Subsidy Calculator, a subsidized silver plan would cost just $158 per month. A bronze plan, meanwhile, would be $0 (4).
This approach enables the couple to maintain the same lifestyle and total income, but pay significantly less for healthcare coverage.
By strategically setting aside some cash reserves, investing in tax-free securities and planning your Roth IRA withdrawals, you can optimize the key factor the government uses to calculate your health care subsidies before you reach 65.
Even if you can’t completely eliminate health care costs like the example above, a few simple adjustments could still make a big difference to your monthly premiums.
But remember, the U.S. health care system is not only complicated and expensive but also constantly evolving.
Lawmakers in Congress could change subsidy levels or income thresholds for support programs at any time, so it’s wise to consult an expert to create a financial plan that can adapt quickly to new rules.
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We rely only on vetted sources and credible third-party reporting. For details, see our editorial ethics and guidelines.
Kaiser Family Foundation (1); Kaiser Family Foundation (2); Healthcare.gov (3); Kaiser Family Foundation (4)
This article provides information only and should not be construed as advice. It is provided without warranty of any kind.
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