Marketplace Subsidy Loss Rate

The Marketplace has made it significantly easier for part-time workers, entrepreneurs, and early retirees to get health insurance. The American Rescue Plan increased the subsidy amounts for Marketplace plans and expanded who was eligible to receive the subsidies for 2021 and 2022, while the Inflation Reduction Act extended these changes through 2025. Marketplace users should be aware of how their income affects their subsidies, especially while the enhanced subsidies are available. Since ACA Marketplace subsidies decrease as income increases, Marketplace users effectively have an additional tax on their income. Knowing how much that “tax” is can feel like a bit of a black box, so I will walk through how to find what I will call the “subsidy loss rate”.

This blog post is intended to help Marketplace users think about the tax implications of this system. This information is particularly relevant for early retirees who have high insurance costs and may be carefully implementing tax strategies like Roth conversions during these “gap years” between work and required minimum distributions. The bulk of the analysis will be for 2025 while the enhanced subsidies are available. While the strategy for 2026 is similar, the rules are likely going to be different with the enhanced subsidies expiring—something very important for Marketplace users to keep in mind.

Background:

As a result of the Affordable Care Act, the Marketplace system rolled out in 2014 as a central location where people could pick between non-group insurance plans (meaning insurance plans for people who could not get coverage through an employer, Medicaid, or Medicare). Plans sold on the Marketplace cannot deny people coverage based on pre-existing conditions, and premiums for the same plan can only vary by location, age, and tobacco status. The plans offer comprehensive coverage thanks to a set of minimum essential benefits which require plans to include things which were frequently excluded from non-group insurance plans (maternity care, mental health, prescription drugs). While the plans may be subsidized by the federal government based on family income, the plans are sold by private insurance companies. The numerous plans enrollees can pick between are classified by metal tiers (bronze, silver, gold, platinum) to help convey how much of total medical bills are likely to be picked up by insurance.

How Marketplace Subsidies Work:

Subsidies are based on the family’s income as a share of the federal poverty line (FPL), with higher subsidies for people at lower FPLs. The federal poverty line in 2025 is $15,650 for one person and an additional $5,500 for each additional person. To get income as a share of the federal poverty line, you divide modified adjusted gross income by the poverty line for your family size. For example, an individual with $70,000 of income would be at 447%FPL (=70,000/15,650), while a couple with $70,000 would be at 330%FPL (=70,000/21,150). Importantly, the relevant form of “income” here is a Modified Adjusted Gross Income (MAGI), which takes the Adjusted Gross Income from line 11 of Form 1040 and adds untaxed social security benefits, tax-exempt interest, and untaxed foreign income. For most people, MAGI and AGI are the same, but the “untaxed social security benefits” could be important for early retirees who have turned on Social Security.

As originally set by the Affordable Care Act, Marketplace subsidies are available for people between 100 to 400%FPL. Due to the Biden-era policy expansions, for 2021-2025, people below 100%FPL or above 400%FPL can also receive subsidies. The 100-400%FPL requirement presumably will be relevant again, assuming the Trump administration doesn’t extend those policies. There are two types of subsidies for Marketplace insurance: cost-sharing subsidies and premium subsidies. The Cost Sharing Reduction (CSR) is a subsidy for people whose family income is below 250%FPL and who pick a silver plan. This significantly reduces the deductible, coinsurance/copay, and out-of-pocket maximum that come with a silver plan. While the CSR subsidies are important to be aware of if it is possible for income to be below 250%FPL, this blog post is going to focus instead on the second type of subsidy: the Premium Tax Credits (PTC). The PTC reduces the premium paid, with larger subsidies going to families with lower FPLs. When enrolling in a Marketplace plan, people estimate their income for the year and then will generally pay their monthly premiums reduced by the estimated PTC. The PTC amount is sent to the insurance company directly. At tax time, the PTC amount is finalized so that people who overestimated their income will get some additional PTC as part of their tax return whereas people who underestimated their income will have to pay some (or potentially all) of the PTC they received back. People who are eligible for Medicaid or an affordable employer sponsored plan are not eligible for PTCs.

The details of the PTC calculation:

Understanding the tax strategy around Marketplace PTC requires a deeper dive into the mechanics of how they are calculated. Insurers selling Marketplace plans set the premiums for their plans, and these premiums depend on things like location and quality of the plan. For a given plan, older individuals are charged higher premiums according to an age curve set by policymakers. For example, a 64-year-old would pay 3x the premium that a 21-year-old would pay for the same plan. Family premiums are the sum of the individual premiums for the family members. This is different from insurance through an employer, where the premium for a family plan (employee, spouse, and one or more children) doesn’t depend on age and generally costs the same regardless of how many children are on the plan.

The PTCs make it so the effective premium for the benchmark plan is not based on age or even the number of family members on the plan, but a percent of household income. The benchmark plan is the “second lowest cost silver plan” (SLCSP) which is the silver quality tier plan that has the second lowest premium. This helps provide a market-derived measure of costs of insurance in that location that updates annually so that people facing higher premiums receive higher subsidies. While the PTC is calculated based on the benchmark plan, the PTC can be applied to any plan available on the market.  Suppose someone’s SLCSP is $400 (monthly) and their PTC is $300. The person could purchase the SLCSP for $100 or purchase a bronze plan with a $325 premium for $25. If the person purchased a plan that was less than $300 a month, they would pay $0 and their monthly PTC would be equal to the premium (so less than $300). To keep this discussion simpler, this analysis written as if people pick the SLCSP. The tax implications are the same regardless of the plan selected, as long as that plan’s premiums are the same or higher than the PTC.

Table 1: Percent of income to pay for benchmark Marketplace plan based on household FPL 2021-2025

 The amount a household is expected to pay in premiums for the SLCSP  is determined according to Table 1. The percent of income they pay depends on their household’s income as a percent of the FPL. For example, recall the individual with $70,000 which corresponded to 447%FPL. Their income is above 400%FPL, so the individual is expected to pay 8.5% of their income for the benchmark insurance plan which would be $5,950 annually (=70,000*.085). If their SLCSP would cost $9,000 a year, they would get a PTC of $3,050 (=$9000 - $5950). (If the annual premium was less than $5,950 they would simply pay that premium and not get any subsidy since their unsubsidized premium would be less than 8.5% of their income). Before 2021, this individual would not have been eligible for Marketplace subsidies since their income was about 400%, and that may be the case after 2025. The current enhanced PTC policies give this individual an extra $3,050 a year. Also note that those below 150%FPL pay $0 annually for the SLCSP, but if these individuals are eligible for Medicaid they are not eligible for PTCs.

Finding the share of income that should go towards the SLCSP premium is more complicated for those between 150-400% because it isn’t directly on the table. For each band of FPL, the share increases linearly between the initial and final percentage. Between 150-200%FPL the share of income increases linearly from 0% to 2%, so for every 1 percentage point increase in FPL, the share of income increases by 0.04%. That happens to also be the rate for 200-300%, but for 300-400%FPL everyone 1 percentage point increase in FPL increases the share of income by 0.025%. This is perhaps clearer in graphical form, as I created below with Figure 1. Additionally, this can be calculated with the piecewise function Equation 1.

Figure 1: Percent of income to pay for benchmark Marketplace plan based on household FPL 2021-2025

The PTC is the difference between the SLCSP premium and the share of income you are expected to pay multiplied by income (Equation 2). Note that income reduces the PTC in two ways here. First, it increases the share of income the family must pay. Second, that higher share is multiplied by the higher income base.

 People thinking about tax strategies are often thinking on the margin with tax rates—how much taxes increase for an additional dollar of income. Marketplace users thinking carefully about tax strategies similarly want to know how much subsidy they lose for an additional dollar of income—I call this the subsidy loss rate (SLR). Mathematically, this can be done by taking the derivative of PTC with respect to income. (If you are near retirement and haven’t thought about derivatives since high school, you could just calculate the PTC at one income and the PTC at that income plus one dollar, and then find the difference in those PTCs.) Since the share of income function is a piecewise function, this derivative also must be done in pieces based on the FPL bands (currently below 150%, 150-300%, 300-400%, and 400%+). Additionally, because the share of income is based on income as a percent of the FPL, the SLR is a function of income divided by the FPL which varies by family size. Two families with the same income but different family sizes will have different SLRs because the FPL is different between the families. It is easiest to see this in graphical form.

 Below is the graph of the SLR by income for a single individual, and it looks strange! You notice that between 150-300%FPL SLR increases linearly with income and then drops before increasing linearly between 300-400%FPL. This linear relationship reflects that the share of income is increasing linearly in those regions. At 400%FPL, the SLR is a flat 8.5% which continues until whatever income where 8.5% of income is more than the SLCSP, or stated differently, where the subsidy has phased out to $0.  

Figure 2: SLR vs MAGI for Different Family Sizes

Figure 2 Panel A shows the SLR by MAGI for households with one member. Panel B shows the same graph for a household with two members. Again, the SLR differs by family size because it is partially related to the share of the federal poverty line, which is a function of family size.

Combining with Marginal Tax Rates

That SLR is somewhat similar to marginal tax rates (MTR) for income tax. With income tax, people take their AGI (line 11 on Form 1040) and subtract some deductions (standard or itemized) to get taxable income (line 15 on Form 1040) and then pay 10% on the taxable income in the first bracket, 12% on taxable income in the second bracket, and so forth. Consequently, higher income people pay a higher percent of their income in income taxes (average tax rate increases with income), just like how higher income people receive less subsidy.  However, there are a couple key differences:

·   The two “taxes” apply to different tax bases. The MTR applies to taxable income whereas the SLR is based on MAGI. Taxable income=AGI-standard or itemized deduction whereas MAGI= AGI+ untaxed social security benefits +untaxed foreign income + tax-exempt interest income. This means MAGI is higher than taxable income.

·   The MTR is flat within a bracket, whereas the share of income towards the premium increase linearly for incomes between 150-400%FPL. 

·   While MTRs are higher for higher tax brackets, the rate only applies to income in that tax bracket. However, with the Marketplace, a $1 increase in income increases the share of income paid for insurance premiums for that dollar and all earlier dollars.

When Marketplace users think about tax strategies, it helps to combine the MTR and the SLR to get a more comprehensive view of how much an additional dollar of income costs. An additional dollar of income will often mean more taxes and less PTC. Since the tax bases are different, a first step is to make both taxes based on AGI. To do that, I will assume that the three additional income sources for MAGI that get added to AGI are $0. Next, I will assume people take the standard deduction. AGI from $0 up to the standard deduction will be the 0%MTR and all the tax brackets will be adjusted up by the standard deduction. Itemizers could do something similar using whatever their itemized deduction amount is. The MTR will depend on tax filing status (married vs single) and the SLR depends on family size, so both of these family structure variables are important.  

Figure 3 shows for an individual (family size=1, unmarried) what the SLR, MTR, and combined SLR+MTR would be by MAGI.

Figure 4 is similar but for a married couple (family size=2, married)

What happens after 2025?

Presumably, the enhanced subsidies which were expanded temporarily through 2025 by the Biden administration will expire at the end of 2025. The calculations for the PTCs will likely return to something similar those in 2020. This would mean that the share of income expected to pay for insurance premiums will be higher at every FPL level (and the PTC therefore lower) and there will be no PTCs available for people above 400%FPL.

Here is what the share of income a household was expected to pay for the SLCSP in 2020, before the enhanced subsidies:

Table 2: Percent of income to pay for benchmark Marketplace plan based on household FPL 2020

 Going back to the individual whose MAGI is $70,000, suppose the benchmark plan has a monthly premium of $880. In 2025, the individual would be at 447%FPL, so the share of income towards the premium would be 8.5%, giving a PTC of $4,616.96 (=880*12-.085*70000). Assume the poverty rate and the benchmark premium stay the same in 2026. This person would not receive a PTC in 2026 because they would be over 400%FPL. If they reduced their income to $62,599 to be just under 400%, their PTC would be $4,437.82=( 880*12-.0978*62,599) (premium according to the table above is 9.78% of income instead of 8.5%).

Assuming tax brackets and the standard deduction stay the same, a MAGI of $70,000 would mean $7,014 in taxes and $0 in PTC, for a net of $62,986. But a MAGI of $62,599 would mean $5,386.78 in taxes and $4,437.82 in PTC, for a net of $61,651.04. (This situation is outlined in the table below since that was a lot of numbers in sentence form).  The extra $7,401 more of MAGI only results in $1,334.96 after-tax-and-PTC income. That means the extra $7,401 is “taxed” at 82%!

Table 3: Hypothetical Tax and PTC Example for After Enhanced PTCs Expire

As evident by the example, the reinstatement of the 400%FPL cliff becomes very important for early retirees because they generally face expensive unsubsidized premiums due to their age. As long as they are eligible for subsidies, the PTC can be quite large. However, having $1 of income that crosses over the 400%FPL cliff could mean missing out in thousands of dollars in PTCs.