The Heloc Method To Avoiding ACA costs in early retirement

One of the biggest challenges of early retirement is health care costs. The insurance market has been broken since Obamacare was passed and the ACA cliffs create a big challenge for early retirees. I touched on this idea in an earlier article on planning for ACA penalties in early retirement and I wanted to expound on this idea. Using A Heloc as a buffer to delay withdrawals and not recognize income, while still benefitting from additional spending is a realistic strategy for minimizing ACA premium costs.

Who Could This Work For?

This strategy is for retirees under the age of 65. At 65 retirees can sign up for Medicare, which costs FAR less than ACA insurance plans.

This plan works well for people looking for a boost above the 400% of Federal Poverty Level ACA cliff.  The FPL for a family of 2 is $21,150. 400% of this is $84,600. This solution would work well for a couple wanting to live off of $100,000 a year, but probably not for a couple wanting to live off of $200,000 a year.

For a couple age 55, at 399% of FPL the couple will pay $576 per month for a silver plan, 8.48% of their income, receiving a $1,090/mo premium tax credit. At 401% of FPL they would be paying the full $1,666/mo. The cost of earning $1 about the 400% cliff is $13,080. This cost increases each year as age is a factor in insurance cost.

ACA premiums are the biggest wildcard in expense planning in retirement. In no other category of spending can there be so much variance in the cost of the exact same product. Early retirees need to find solutions around this.

The Roth Solution:

Qualified withdrawals from Roth accounts do not count as income towards the ACA threshold.  In a perfect world an early retiree would enter retirement with over half their assets in Roth accounts, but that is highly unlikely.  In order to benefit from Roth withdrawals a lot of pre-planning must occur prior to retirement. The Heloc strategy can be implemented at any time. Many people who are retiring now have most of their savings in non Roth accounts. While Roth IRAs have existed for decades, their contribution limits have been much lower than 401Ks, and Roth 401Ks are a relatively new product that still is not universally offered.

The Heloc Solution:

In order to be able to spend money above the 400% of FPL level to avoid falling off the ACA cliff consider tapping a heloc (home equity line of credit) rather than a traditional IRA or 401K. Proceeds from loans are not considered income.

For someone with home equity of $300,000 a bank will generally extend a line of credit for $240,000. I used the $300,000 number as this is the average home equity for someone in this age group.

In this example, say we want to spend an extra $20,000 per year.  Most helocs currently have an interest rate of 7%. It is very common to get a heloc with a 10 year “interest only” set up.

To borrow $20,000 from a heloc would cost $1,400 per year for each year it is used. The interest is also only charged for the months where the money has been withdrawn. If the couple live off of their 401K withdrawals and other income first in the year, then withdrawal $10,000 a month for November and December,  their interest cost would only be $175 for the year.

$20,000 per year over the $84,600 400% of FPL threshold is a 23.6% increase in yearly spending.

Setting up a heloc is very easy and takes less time than a typical mortgage. I would suggest setting up the heloc prior to retirement, as banks find underwriting much easier if they have W2 income to work with.  Heloc’s generally have very low closing costs of only a couple hundred bucks and the appraisal is often an e-appraisal where they don’t have someone go into your house and charge $700 to compare to other homes.

Option 1: $20,000 heloc withdrawal per year through hitting Medicare at age 65.

This option results in saving just over $100,000 in net fees. $100,000 is significant savings for most people. At age 65 they will take a one time $200,000 withdrawal from their retirement accounts to pay off the accrued heloc balance they have been living off of. They take the yearly $20,000 out as $10,000 in November and $10,000 in December each year.

The total savings is the value of the ACA credit provided minus the cost of the heloc interest payment in the given year. This savings ins real because the alternative would be recognizing that $20,000 as income withdrawn from a traditional 401K account and falling off of the ACA 400% cliff.

This plan still has a weakness.  Even though every year the couple is coming out ahead, the interest owed really adds up at the back end and the yearly savings is much less for the last 5 years.

Option 2: Take A Large Distribution At 60 to pay off the loan.

Run the same plan, but in year 6 take a large distribution and pay off the heloc, as well as withdrawal for the next year while staying in a low tax bracket.  For Year 6 this would be withdrawing the original $84,600 to fill the 399% of FPL, the $100,000 for the accumulated Heloc debt, and $60,000 to cover the current year and year 7 and 8s overage.  This is a total of $244,600. This would have the couple just barely exceeding the 22% tax bracket. ($32,200 standard deduction and $211,100 for the 22% tax bracket)

In this scenario the couple ends up saving an additional $30,000 between ACA credits and interest expenses.

Additional Savings:

I used the 7% interest rate that I am currently paying for my heloc, however it is very probable that rates can and will be reduced in the future.  A 5% heloc interest rate in Option 1 would result in an addition savings of $18,500 and in option 2 would save almost $5,000.

We also have the unknown of future ACA premium hikes. I am using real 2025 numbers for all of the ACA premiums.  Over a 10 year period of time it is highly likely that ACA premiums will continue to rise at a fast rate, extending the total savings this model provides. ACA premiums have certainly increased greatly over the last 10 years.

Additional Earnings:

Another benefit of this strategy is that it allows money to stay invested in retirement accounts longer, likely out earning the interest being accrued.  In option 1 we delay taking $200,000 of distributions over the course of a decade. This allows the money to stay invested. If the average yearly returns are 10%, then the couple would also be gaining an additional roughly $150,000 in market gains.

Risks:

Helocs come with a few risks:

1. Interest rate: Interest rates with helocs can fluctuate, which is why I am using a high interest rate in my projections.  When I first got a heloc the interest rate was only 3%. After covid the interest rate run up brought my heloc up to 9.25%. Since they are currently 7% and have been on a downward trend I think it is more likely rates will fall vs. rise.
2. Freezing The Line: Banks have frozen lines of credit to shore up their balance sheets in the past. This happened on a wide scale during the 2008 financial crisis.
3. Home is mortgaged, and the payoff depends on investment accounts,. If there is a series of negative market returns when it is time to end this process and pay off the heloc, staying to this plan could be detrimental and it may be better to hold off for a recovery before paying it off.

Does This Work For More Money? What About $30,000 per year?

Yes, but less effectively. The more money that is borrowed the higher the borrowing cost and the less savings.  When looking for a higher payout the 2nd option of taking a year in the middle of early retirement to fall out of the ACA guidelines and pay off the heloc becomes a more attractive option. Taking out $30,000 per year is 34% higher than the 400% of FPL number.

Option 1, no different than the original: $70,000 of savings vs. $103,000 of savings.

Option 2: Slightly modified: Still taking a large distribution and falling off the cliff in the 6th year, also paying an additional tax of 2% for jumping into the 24% bracket for roughly $80,000 of distributions, for a $1,600 extra cost. In this scenario the cost savings is $124,000 vs $134,000. Option 2 makes more sense at this level.

What do you think of the Heloc method to avoid paying ACA premiums?