The Patient Protection and Affordable Care Act, better known as Obamacare, continues to inspire heated debate between supporters and opponents, with plenty of disagreement even years after it initially became law. Yet even though Americans have become more familiar with Obamacare, there are still some little-known provisions that can snare the unwary. One particularly onerous hit can cost you thousands of dollars in Obamacare subsidies, and it can strike if you earn even a single dollar above a limit that the healthcare law imposes. Let's look more closely at what has become known as the Obamacare subsidy cliff and why it can cost you thousands of dollars if you don't take action to avoid it.
Understanding Obamacare subsidies
The Affordable Care Act encourages Americans to participate by offering subsidies for qualifying healthcare coverage to those who fall below certain income limits. In particular, Obamacare subsidies are available to those with incomes up to 400% of the federal poverty level, making the key figures for 2015 $47,080 for single-person households, $63,720 for couples, and $16,640 in additional income for every extra person within the household.
If your income falls below 400% of the federal poverty level, then the most that you'll have to pay in out-of-pocket costs for your health insurance premiums is 9.5% of your income. For those who are right at the line, that means that single-person households have a maximum premium of $4,473, while couples will pay no more than $6,053 and larger families will have premium maximums that are about $1,581 higher for every additional person.
It's difficult to quantify the exact amount of the subsidy that those who earn 400% or less of the federal poverty level get, because premium costs under Obamacare vary widely from state to state as well as by family size and level of coverage. Nevertheless, the impact of these and other subsidies under Obamacare can be huge. According to the Department of Health and Human Services, nearly everyone who buys insurance on federal exchanges qualifies for subsidies, and the average premium reduction for those getting subsidies was 72%. That figure includes other reductions in healthcare costs available to those who earn lower amounts of income, but even so, qualifying for the maximum premium limitation can cut thousands of dollars off your health insurance premiums in any given year.
The Obamacare subsidy cliff and you
The problem with the Affordable Care Act is that the income limits it sets are harsh lines in the sand. If your earning exceed the limit by any amount at all, then you suddenly are no longer eligible for any subsidies at all. Thousands of dollars in Obamacare support can therefore vanish simply because your income rose above the limit by a single dollar.
In particular, the definition of income for Obamacare subsidy purposes is modified adjusted gross income. To calculate that amount, you take ordinary adjusted gross income, which includes income from sources including work, investments, taxable pensions, unemployment, business earnings, and rental real estate, and then deducts certain items like IRA contributions and eligible student loan interest. Then, though, you have to add in any Social Security benefits that weren't included for federal income tax purposes, as well as tax-exempt interest and any foreign earned income that didn't get taxed at the federal level.
How to avoid the Obamacare subsidy cliff
As a result, in order to avoid losing your Obamacare subsidy, it's crucial to take a close look at your modified adjusted gross income. Timing your income so that you don't exceed the income limits can help you avoid nasty surprises.
For many people, income is a relatively fixed number. But for some, it's easier to keep income below the limit. If you retire early, for instance, deferring Social Security can prevent you from inadvertently exceeding the income limit, as can drawing money from tax-free Roth IRAs rather than from taxable traditional IRAs and 401(k) plans. For those of any age, avoiding sales of investments that have risen in value can help you keep capital gains income down, which otherwise could send you above the limit. Similarly, making sure you take advantage of deductions that will reduce your modified adjusted gross income can mean the difference between getting thousands in subsidies and getting nothing.
Obamacare is controversial for many reasons, and one is that some of its provisions can be difficult to understand. By being aware of the Obamacare subsidy cliff, you can take steps to make sure you steer well clear of it and get the subsidies that you're entitled to receive under the law.
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