Journal of Financial Planning: September 2012
David M. Cordell, Ph.D., CFA, CFP®, CLU, is director of finance programs at the University of Texas at Dallas.
Thomas P. Langdon, J.D., LL.M., CFP®, CFA, is professor of business law at Roger Williams University in Bristol, Rhode Island.
On June 28, 2012, the United States Supreme Court issued its historic decision on the Affordable Care Act. Chief Justice Roberts, writing for the majority, stated that the law’s insurance mandate passes constitutional muster under the federal government’s taxing authority, although not under the power of the Commerce Clause. The decision has been termed both a brilliant stroke of judicial legerdemain and the worst decision in the history of the Court.
Regardless of our personal opinions, planners must evaluate the law’s implications for their clients. Indeed, to the extent that we consider the new law in terms of risk management rather than politics and personal philosophy, both planner and client will probably be happier.
The Short Term: How the Act Affects Planning
Except for rate increases, the immediate impact of the Affordable Care Act may be minimal for most clients. Financial planners have long appreciated the risk-shifting benefits achieved by purchasing health insurance, and those benefits are unaffected by the Affordable Care Act.
The new tax on the failure to buy health insurance provides an incentive for individuals to obtain that insurance. To the extent that clients have resisted purchasing health insurance, the threat of a penalty (as the Act calls it) or a tax (as the Supreme Court calls it) may encourage clients to act on risk management programs proposed by planners.
For most clients, the Affordable Care Act does not change the approach to risk management that financial planners have employed for decades. Health insurance continues to be an important part of the risk-management portfolio.
The Road Ahead Is Paved with Benefits and Taxes
Two of the more popular aspects of the law that affect children, including the provision prohibiting discrimination against those with pre-existing conditions who are under 19 and inclusion of children up to age 26 as covered individuals on their parents’ policies, may have already benefitted your clients. Similarly, the elimination on lifetime limits and the phase out of annual limits, to be completed in 2014, are notable advantages. Beginning in 2014, no one can be denied coverage due to a pre-existing condition or have coverage that excludes benefits for a specific medical condition. These benefits reduce risk exposure for the client.
Of course, potential increases in premiums and reductions in health-care quality are concerns. Further, some individuals will be directly and adversely affected by the provisions of the Act, including those who do not currently purchase health insurance, and moderate and high-income individuals, whose taxes will increase to fund the Act’s mandates.
Those without health insurance coverage will either have to obtain qualifying coverage or pay a tax, beginning in 2014, which rises until 2016, when a married couple would pay a surtax equal to the greater of $1,360 or 2.5 percent of adjusted gross income. Clients who do not currently have health insurance may wish to purchase insurance by 2014 to avoid the imposition of this tax.
High-income individuals will also see a rise in taxes to fund the Act’s provisions. Individuals making more than $200,000 and couples making more than $250,000 (note the significant marriage penalty imposed here) will pay a Medicare surtax of 3.8 percent on their investment income, plus an additional 0.9 percent Medicare payroll tax beginning in 2013. Assuming that Congress does not extend the Bush tax cuts, this means that capital gains tax rates for high-income individuals will rise from 15 percent to 23.8 percent, and rates on dividends and interest will rise from 15 percent to 43.4 percent beginning in 2013. Planners may wish to meet with clients whose income exceeds these amounts to consider possible reallocations of assets into products that are exempt from the surtax.
The tax hikes to fund the Act are not limited to high-income earners. Some of the tax hikes affecting middle- and low-income earners include the limitation on contributions to flexible health care spending accounts (since 2011), the increase in the itemized deduction floor that applies to medical expenses (beginning in 2013), the increase in the penalty tax on health savings account withdrawals (since 2011), and the surtax on indoor tanning services (since 2010).
The limitation cap of $2,500 (down from $5,000) on contributions to health care flexible spending accounts was the subject of one of our previous columns. By reducing the maximum contribution, the Affordable Care Act subjects the difference to both income taxes and Social Security taxes. The additional taxes that have to be paid may be significant for individuals who have high-deductible health insurance plans and who are funding the out-of-pocket costs with flexible spending accounts. Planners who advise business owners may want to suggest that the businesses use health savings accounts (HSAs) as an alternative to flexible spending accounts, because they are not subject to these limitations. Don’t put too much money into the HSAs, though. Since 2011, distributions for purposes other than health care expenses are subject to a 20 percent penalty tax.
Beginning in 2013, the floor that applies to qualified medical expenses on income tax returns increases from 7.5 percent to 10 percent. This floor effectively eliminates medical expense deductions for most working clients with health insurance, but some clients who have family members in long-term-care facilities, or who are paying long-term-care premiums, may be able to obtain a partial deduction for those costs. Planners may wish to meet with clients who have been receiving an income tax deduction for medical expenses to determine whether reallocation of some of these expenses would make sense. For example, it may make sense to move from a traditional to a high-deductible health insurance plan so that the client can open an HSA and make above-the-line tax deductible contributions (without regard to the 10 percent floor) to the HSA.
Is a Cadillac in Your Future?
Perhaps one of the most perplexing tax increases imposed by the Affordable Care Act is the tax on “Cadillac” health insurance plans. Beginning in 2018, there will be a new 40 percent excise tax on high-cost health insurance plans. A high-cost health insurance plan includes a plan with premiums of at least $10,200 for single coverage, or $27,500 for family coverage. These thresholds were set by the Affordable Care Act in 2010, and will not be adjusted for inflation through 2018. This means that as health insurance premiums rise from now through 2018, and you can bet your Lexus they will, more and more health insurance plans will fall into the “Cadillac” plan classification.
Although the 40 percent tax is imposed on the insurer, it will almost certainly be passed through to consumers. Planners may wish to consider switching some of their clients from traditional indemnity-type plans to high-deductible plans (in conjunction with an HSA) as 2018 approaches to avoid the 40 percent surtax. What makes this tax perplexing? While the Act’s objective is to ensure that Americans are covered with health insurance, Americans who buy the best health insurance are punished for doing so through imposition of the 40 percent surtax.
Business Owners, Beware
Planners who counsel small business owners must evaluate the new employer mandate tax, which becomes effective in 2014. It states that employers with 50 or more employees must either offer “affordable” health coverage or pay an additional non-deductible tax of $2,000 per full-time employee ($3,000 for employees who obtain health insurance coverage through the new health insurance exchanges). “Affordable” means that insurance coverage must pay at least 60 percent of health-care expenses and the employee must not be required to pay more than 9.5 percent of family income for coverage. Good news: the first 30 employees are excluded from the calculation of the tax. Bad news: the law considers two half-time employees equal to one full-time employee.
When the employer mandate tax is considered, the marginal cost of adding the 50th employee to the payroll may be prohibitive for those employers not currently offering health insurance coverage. Small business owners may wish to maintain a workforce of fewer than 50 employees to avoid this result, possibly through the use of independent contractors to perform supplemental work.
Should your business owner client forgo employee health insurance and simply pay the tax? That analysis is part business decision and part personal values. But keep in mind that the taxes will likely increase as fast as insurance premiums, while employee morale will decline even faster.
The Future Is Uncertain
From a personal financial planning standpoint, the Affordable Care Act has the effect of reducing risk for most clients, notwithstanding whether the price is reasonable or the law is well designed. Indeed, many planners will rejoice that the law’s provisions enforce aspects of risk management that could only be suggested in the past.
One thing is certain: the Act will spawn many regulatory and legislative actions in addition to changes in the health insurance market. For some clients, the changes can be significant, while for others, they will be minimal. Competent planners must monitor these developments and employ appropriate strategies to serve their clients’ best interests.