I wrote a couple of posts in the past about how the ACA subsidies work, and how the phase-out of the premium tax credit acts as a separate tax that sits on top of regular income tax rates.
Congress recently passed another round of COVID-19 stimulus, and President Biden has signed it into law. Part of this law is a change to the computation of the ACA premium tax credit. An update to my earlier analyses are therefore in order. The law changes the tax credits for 2021 and 2022. We are scheduled to revert to the previous tax credit amounts in 2023.
In a nutshell, the law does two main things for ACA marketplace customers: it increases the premium tax credit for everyone who previously qualified for one, and removes the cliff at 400% of the poverty level that prevented people slightly above this level from receiving any subsidy.
A graph of this difference is below, for a single person whose second-cheapest silver plan has a gross premium of $9,500 per year.
A few things stand out here:
1) There’s no difference below 100% of the poverty line. The cliff at this level remains. In expanded-Medicaid states, people in this range will typically be eligible for Medicaid coverage. In the remaining states, people in this range will often find health insurance to be completely unaffordable.
2) Between 100% and 400% of the poverty level, the tax credits are a bit bigger than they were before, almost $1,500 larger at some income levels. This includes lowering the net premium to $0 for people between 100% and 150% of the poverty level.
3) Above 400% of the poverty level is where things can be really different. Under prior law the premium tax credits cut off abruptly at this income level. The older you get, the more your unsubsidized premiums will be, and the steeper this cliff was. The new law smooths out the curve significantly. The subsidies still phase out at higher incomes, but it is now a gradual decrease rather than a sharp cliff.
What about the marginal rates?
One thing that I think continues to be overlooked in the retirement tax planning space is how the phase-out of premium tax credits affects marginal tax rates for people who purchase health insurance from the ACA marketplace. This phase-out adds a rather significant amount to the marginal rates, and this can in turn affect decisions workers make about whether traditional or Roth retirement contributions would be more advantageous.
The graph below plots the marginal rates under prior law just from ACA premium tax credit phase-outs, compared to the new 2021 law.
The blue line is the same as from my earlier post about this topic. From 100-133% of the poverty level the net cost of the second-cheapest silver plan (the “applicable percentage”) was formerly a flat 2.06% of MAGI, so that’s the marginal rate we saw. From 300-400% of the poverty level the applicable percentage was fixed at 9.78% of MAGI, so that again was equal to the marginal rate.
Between 133-300% of the poverty level, the applicable percentage gradually increased from 2.06% of MAGI to 9.78% of MAGI. This increase caused the marginal rate to actually be higher than 10%, because as your income increased the new applicable percentage that you’d pay for your health insurance was applied to your entire income (not just your marginal income).
The red line shows the marginal rates that arise from the new law. Notice the new 0% applicable percentage below 150% of the poverty level, resulting in no marginal tax from the subsidy phase-out in this range. The new law also creates lower marginal rates between 150-300% of the poverty level, as the applicable percentage is increasing a bit slower than before.
Above 300% of the poverty level we see a different story. The red line is actually higher than the blue line in this range. Instead of having a fixed applicable percentage between 300-400% of the poverty line, the new law has the applicable percentage gradually increase here. This has the effect of pushing the marginal rate up above the applicable percentage in this range, just as we’ve already seen elsewhere.
Once we exceed 400% of the poverty level, the new law fixes the applicable percentage at 8.5% of MAGI. This 8.5% number is the marginal rate we see up until the credit phases out based on the cost of your insurance. Previously we had a marginal rate of 0% here because once you fall off the cliff your health insurance would cost the same at 401% of the poverty level as it would at 500% or 600% of the poverty level. Under this new law that would no longer be the case. This makes the ACA marginal rates now apply to higher income levels than before.
We can see from the first graph that people at most income levels will be paying less for health insurance through the ACA marketplace in 2021 than they would under the rules in place previously.
We can see from the second graph that the marginal rate paid toward insurance premiums will also go down for people below 300% of the poverty level, while it will go up for people above 300% of the poverty level.
For people still in the accumulation phase, this might be a good time to re-evaluate your retirement account contribution decisions. If you’re targeting an income below 300% of the poverty level while you’re on the ACA, traditional contributions may look like a slightly better deal now than before, and Roth is looking a bit worse. The opposite is true if you’re expecting an income above 300% of the poverty level.
On the other hand, this new law is only set to be in effect for two years. If it is allowed to sunset, we’ll revert to the previous rules, and changing your long-term plans based on this will prove to be a mistake. If on the other hand this change proves politically popular, it could be extended beyond 2022 and in fact remain in place for some time. You’ll need to use your own judgement to decide which of these outcomes seems more likely and plan accordingly.