Wednesday, September 7, 2016

The Strange Mathematics of Early Retirement and Obamacare

How does Obamacare work for those who are forced into early retirement?

I wrote about early retirement and Obamacare and how it might make early retirement easier for some retirees.   This assumes, however, the retiree qualifies for Obamacare, of course, and that their income won't take them outside of the tax credit subsidy limits.

I met a fellow the other day and had an interesting conversation about early retirement.  Like most people, he had early retirement thrust upon him rather than planned out.  He worked for years at the mill at a Union job, but saw the writing on the wall.  When the layoffs came, he had paid off his house and cars and had no debt.   Good for him.  Smart move.   Others at the mill weren't so smart and found themselves on the street with a mountain of debt and no way to make money.

He made sure his kids learned skills rather than relying on union jobs at the mill.  One is an electrician and the other a journeyman plumber.   Good for them.  Smart move.  They both have jobs and careers and skills that are in demand.   Dad, however, is scraping by on part-time jobs, as no one wants to hire a 50-something former union employee these days.   It is tough.

His largest expense is health insurance - about $850 a month on his wife's policy at her place of work (the local school).   It is a pretty staggering amount and sure to go up before he reaches age 65 and can qualify for medicare.  He claims that he can't qualify for Obamacare as he is covered by his wife's policy.  I am not sure if that is true or not.  If so, it is grossly unfair as we shall see below.   He is paying a lot of money for insurance and not getting the subsidy.

Speaking of which, why is health insurance so expensive and who is making all the money?  Many folks think (wrongly) that the insurance companies are raking it in.   If so, they are doing a good job of hiding it.  My stock in Anthem (Blue Cross) has dropped by over 20% since I bought it and the stock pays a paltry 2% dividend.   Other insurers don't seem to be doing much better - my agent who is on the board of Humana claims they will ask for a 20% rate increase just to remain solvent.   Other companies are withdrawing from the market as it is unprofitable.

Where is all the money going?   Well, with no checks and balances on pricing, I think a lot goes to drug companies.   One reason you read these articles about "obscene" pricing on drugs like the Epipen is that since insurance is paying for it, no one in the loop "cares" about the pricing.   A "generic" pen is offered to the few people who actually have to pay out of pocket.

The other aspect of health insurance is supply and demand and the market.   Think about it for a minute - how much would you pay to live for another decade, or even a year, a month, a week, or even a minute.   Odds are, you'd say, "whatever money I have" because once you are dead you won't need money, and the will to live is strong.   Medicine - when it works as advertised - is the ultimate "must have" product when it comes to the supply/demand curve.   And even in countries with socialized medicine we see this, as the supply of medical care often dries up in response to demand and the lack of incentive to provide supply.

And medical care can be costly and the results amazing.  Today there are routine procedures that can extend your life by decades - procedures that were "hail Mary" experimental treatments with little prospect for success, only a few years back.  Multi-bypass and other heart operations are quite routine now, as are things like bone marrow transplants.   Routine, but staggeringly expensive.

And then there are things that make the quality of life much better in the declining years.  Hip and knee replacements can change your life completely and add another decade or two of active living.  They aren't cheap, however.   And when they go wrong, well, they can be a nightmare.   Modern medicine can do so many marvelous things, but at a staggering cost - a cost we are all willing to pay if it makes us live longer or live happier.   We'd prefer, however, that someone else pick up the tab.

But regardless of who is making all the money, the bottom line is, health care is freaking expensive.   My friend has to pay out of pocket and can deduct the cost from his taxes.   I can take a tax credit for Obamacare so long as I don't make more than $60,000 a year or so (actually closer to $62,999).   In fact, the staggering cost ($1098 per month) pretty much wipes out my entire Federal tax burden for the year.  So instead of paying Uncle Sam, I now pay Blue Cross.  No word yet on how Uncle Sam intends to fund his budget without my contribution.

My friend who is on his wife's plan can only deduct his premiums, which means if he is in the 25% bracket, he might save 25% of the cost of the premiums off his taxes, while I get a huge tax credit (equal to about 75% of premiums) instead.

This incentivizes me not to make more than $60,000 a year and this raises some interesting issues.   

For example, if I can stay under $60,000 per year, I can get this great tax credit and early retirement is no big deal.  But if my income drops below about $21,000 a year (the so-called poverty line) I would no longer qualify for Obamacare, but would instead have to go on Medicaid - medical care for the poor.

Now this may seem like an unlikely scenario, but it is quite likely.   Since I cannot tap into the IRA/401(k) money until age 59.5 (without a 10% tax penalty) then I must rely on after-tax savings I have accumulated over the years.   Since this money was already taxed, I pay no taxes on it, other than capital gains.   If I have no capital gains, or not much in the way of capital gains, I might end up with an effective income of under $21,000 a year, even if I am spending $50,000 a year or more.

So this means I either have to invent some income to declare to qualify for Obamacare, or take money from my IRA and pay the tax penalty to qualify.  Either way, it gets kind of awkward.

My friend hopes to get a job at the school so he can get on their policy, which would cost only $50 a month as an employee (as opposed to a spouse).  In the meantime, he is handy with tools and can fix his own cars, so he can get by on occasional odd jobs and not have to worry about making a lot of money.   It is just that $850 a month hole in his budget that is really killing him.  Fortunately, he was smart enough to make sure he was debt-free by age 55 so at least he has no mortgage or car payments to deal with.   Others are not so lucky or smart.

Another scenario that troubles me is if we sell our Condo, which is slated to be demolished.   We would be paid about $160,000 for the unit, which would be all capital gains, since the unit is completely depreciated.   As a result, not only would this cause me to pay capital gains tax on the entire amount, but also it would knock me out of the Obamacare subsidy limit, meaning that the entire cost per year for insurance ($13,000 or so) would be borne by me, with no tax credit (although I suppose I could claim a tax deduction?  I need to call an accountant!).    It would be nice if they could pay me in nice $55,000 installments over three years or something.  That would keep me under the Obamacare subsidy limit.

All of of this is new territory as the law is fairly new.   People have been trained over the years how to deal with taxation of social security and how to qualify for medicaid in nursing home care.   Over time, people figure out how to work around the law to minimize their tax burdens.  But the Obamacare system needs some adjustments as it does create some unintended consequences.   The first problem is the staggering cost and figuring out why it is so staggering.  Where is all the money going?  The second problem is to adjust the tax credit system so it doesn't cut off at $62,999 or force you into medicaid at under $21,000.  There are plenty of people who have low declared incomes but can "afford" the premiums of health care, since they are living off of savings.

None of the politicians talk about this of course.  And few citizens understand any of it.  Most folks don't understand the difference between a tax credit and a tax deduction.  Many think even today that you can make money on tax deductions, in fact.  So when you start talking about marginal rates and stuff, well, you lose them pretty quickly.

Of course, one alternative is to go back to work.  The problem is, for many of us this isn't an option.  No on is hiring old people, or at least not hiring them full-time with health insurance benefits.   In fact, few people are hiring anyone with these sorts of "gold plated" benefits anymore.   That is an other unintended consequence of the new health insurance law - if you hire someone full-time, you have to provide health insurance.  So it incentivizes companies to hire part-time labor instead.

I am not saying the system is wrecked or anything, only that the math is, well, somewhat odd.  My friend is doing OK in life - he has a paid-for house and cars, and his wife makes enough such that with his part-time work they can put food on the table.  Their kids are doing well and have good paying jobs.  It is just that they never envisioned that health insurance would be their largest expense in life.

Similarly for me, it is the queer math that is troubling - a system that incentivizes me to make not too much and not too little money, and penalizes folks who strive to rise above a median income.   It also makes figuring out early retirement nearly damn impossible.

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