Early retirees face healthcare cost challenges and tax credit complexities

Because most Americans are not eligible for Medicare before the age of 65, many younger retirees rely on Marketplace health insurance, which has reduced monthly premiums through the end of 2025 thanks to increased tax incentives. However, experts warn that retirees who do not plan ahead of time may face an expensive tax surprise.

The Affordable Care Act, also known as Obamacare, introduced the Health Insurance Marketplace in 2014 to provide more affordable healthcare options for individuals and families. This platform has become increasingly important for early retirees who find themselves in a healthcare coverage gap between leaving their employer-sponsored plans and becoming eligible for Medicare. The Marketplace offers a range of plans with varying levels of coverage and costs, allowing retirees to choose an option that best fits their needs and budget.

According to Kaiser Family Foundation data, more than 5.1 million Americans aged 55 to 64 had Marketplace coverage as of open enrollment in 2024, up from approximately 3.4 million in 2021.

This significant increase in Marketplace enrollment among older Americans highlights the growing trend of early retirement and the need for accessible healthcare options. The COVID-19 pandemic has also played a role in this surge, as many individuals in this age group chose to retire earlier than planned due to health concerns or changes in their work situations. Additionally, the enhanced premium tax credits have made Marketplace plans more attractive and affordable for this demographic, contributing to the rise in enrollment numbers.

In 2021, Congress temporarily increased the premium tax credit, allowing Marketplace registrants to pay cheaper monthly premiums upfront or get the tax reduction when completing their return. The legislation covered 2021 and 2022, but lawmakers extended the benefit to 2025.

With Marketplace benefits related to earnings, younger retirees can benefit from lower premiums after leaving the job. Tommy Lucas, a certified financial planner and enrolled agent with Moisand Fitzgerald Tamayo in Orlando, Florida, claims that some people face a "phantom tax" as their income grows.

"These are very valuable credits," Lucas said, and numerous financial decisions in retirement might affect them. "You have to be extremely careful."

Financial experts stress the importance of comprehensive retirement planning that takes into account the potential impact of various income sources on healthcare costs. This includes considering the timing of Social Security benefits, pension payouts, and withdrawals from retirement accounts. Retirees should also be aware of how part-time work or investment income might affect their eligibility for premium tax credits. Seeking advice from a financial advisor or tax professional who specializes in retirement planning can help individuals navigate these complex decisions and avoid unexpected tax consequences.

How the Premium Tax Credit Works

Before 2021, households earning between 100% and 400% of the federal poverty line were eligible for the premium tax credit. During the pandemic, however, the American Rescue Plan Act temporarily lifted such restrictions and limited premiums to 8.5% of income.

Calculating premium tax credit eligibility might be difficult. It is calculated as the difference between a benchmark premium (the cost of the second-lowest-cost silver plan available in the area) and a maximum contribution based on a percentage of income.

"Changes in reporting circumstances should be reported immediately," said CFP Jim Guarino, managing director at Baker Newman Noyes in Woburn, Massachusetts.

Otherwise, you may overpay or underpay your Marketplace premiums, which are eventually reconciled on your tax return, he explained.

Common Premium Tax Credit Issues

Depending on income, the premium tax credit might save qualified younger retirees hundreds, if not thousands, of dollars annually. However, analysts believe that increased incomes can lead to eligibility being phased out.

"The big one," in terms of affecting eligibility, is collecting Social Security at age 62, because your whole payment, including the nontaxable half, counts into the eligibility calculation for the premium tax credit, according to Lucas.

Long-term predictions show that if you're claiming the premium tax credit, you should wait until you're at least 65 years old to claim Social Security, he added.

This recommendation to delay Social Security benefits underscores the importance of a holistic approach to retirement planning. While it may be tempting for early retirees to claim Social Security as soon as they're eligible, doing so could significantly impact their healthcare costs and overall financial stability. By waiting until age 65 or later to claim Social Security, retirees can potentially maximize their benefits while maintaining eligibility for valuable premium tax credits. This strategy can help ensure a more secure financial future and better manage healthcare expenses throughout retirement.

The similar difficulty can arise when increasing income through so-called Roth individual retirement account conversions, which convert pretax or nondeductible IRA funds to a Roth IRA for future tax-free growth.

However, with several years until needed minimum distributions, Lucas suggested implementing the method later.

"The name of the game, ultimately, is paying minimum taxes, not just in one year or two years, but over your projected lifespan," he pointed out.

As retirees navigate the complex landscape of healthcare costs and tax implications, it's crucial to maintain a long-term perspective. While strategies like Roth IRA conversions can offer significant tax advantages in retirement, timing these moves carefully is essential to avoid unintended consequences on healthcare costs. Retirees should consider working with financial professionals to develop a comprehensive retirement income strategy that balances tax efficiency, healthcare affordability, and overall financial security throughout their retirement years. By taking a proactive approach to planning, early retirees can better position themselves to enjoy their retirement years without the burden of unexpected healthcare costs or tax surprises.