The American Rescue Plan, ACA, and Roth conversions

The American Rescue Plan became law on March 11th, 2021, and I was surprised to figure out that it changes the taxable income we want to aim for in 2021 and 2022 significantly.

Briefly, we’re married filing jointly (MFJ), retired, have two kids under 16 at home, get health care from the ACA (Affordable Care Act) exchange, and want to do Roth conversions.

Since we have IRA, Roth, and taxable investments we can spend from and can choose how much to Roth convert, we have a lot of control over our taxable income.

In recent years, it made sense for us to aim for a taxable annual income just over $100,000. We want the full $4,000 benefit from the two child tax credits, which are not fully refundable, which means at least $61,725 in ordinary income ($25,100 standard deduction + $19,750 x 10% + $16,875 x 12% = $4,000 tax). After that, another $44,425 of qualified income (qualified dividends or long term capital gains) are also tax free.

However, our maximum tax free income of $106,150 goes over the income where ACA subsidies disappear, which is $104,800 (400% of the Federal Poverty Level or FPL).

With our taxable account interest and dividends, we can Roth convert about $52,000 per year with no tax cost other than a reduced ACA subsidy, which is effectively a 9.83% tax and a good deal to us.

However, after reading an excellent summary of the American Rescue Plan, I found out that things will be a lot different for 2021 and 2022.

First, the child tax credit is fully refundable, so we no longer need a particular minimum income to fully use the child tax credit.

Second, the ACA Advance Premium Tax Credit (APTC, or “ACA subsidy” below) will be larger for 2021 and 2022. There’s a “premium percentage” of your income that ACA expects you to pay for health care, but then the subsidy covers the rest of the cost of your local “benchmark plan”. These premium percentages are much lower for 2021 and 2022 at a wide range of income levels. Using the 2020 Federal Poverty Levels:

Together, these two changes mean that a much lower target income is best, because we aren’t losing part of the child tax credit and the ACA subsidy decreases much more quickly as our income increases, acting like a higher marginal tax than normal.

In our case, it looks like our income for the next two years should be about $72,000 (275% of FPL), which is the maximum income at which our (bronze plan) ACA premiums are fully reimbursed.

This will mean doing a $22,000 smaller Roth conversion. Normally that would only save us $2,162 in ACA subsidies (9.83%), in which case we’d rather stick with the bigger Roth conversion. For 2021 and 2022, however, it’ll save $2,640 in federal tax (we’re not losing any child tax credit) and a stonking $5,600 in ACA subsidies, for a total of $8,240, almost four times the normal benefit.

If you receive the child tax credit, buy healthcare from the ACA exchanges, and have control over your taxable income, it’s worth looking to see if you should have a different plan for this year and next.

A few more notes for 2021 and 2022:

• Stimulus checks are officially based on 2021 income, but will be sent based on your latest taxes filed when the IRS initially processes the payments. You don’t have to pay them back if your 2019 or 2020 taxes triggered a higher payment than your 2021 income would qualify for. You may want to delay filing taxes if your 2019 income was lower than 2020.
• Watch out for the $150,000 income level (MFJ) because any stimulus payment and the extra child tax credit very rapidly phase out.
• The ACA APTC is not limited to incomes under 400% of FPL, though your subsidy shrinks as you’re expected to pay 8.5% of your income toward the benchmark healthcare plan.
• There are also dependent care account, COBRA, unemployment assistance, and tuition debt