To avoid the 'phantom tax' on Marketplace health insurance, younger retirees should be aware of these tips.

• Younger retirees often use Marketplace health insurance because it has lower monthly premiums due to increased tax breaks until 2025.
• Proper planning is crucial for retirees to avoid a "phantom tax," as advised by Tommy Lucas, a certified financial planner and enrolled agent at Moisand Fitzgerald Tamayo.
• Earlier Social Security payments or Roth individual retirement account conversions could potentially eliminate Marketplace tax credits.

Many younger retirees rely on Marketplace health insurance due to lower monthly premiums, but they can face a costly tax surprise without proper planning, experts warn.

The number of Americans aged 55 to 64 with Marketplace coverage increased from about 3.4 million in 2021 to more than 5.1 million as of open enrollment 2024, according to data from the Kaiser Family Foundation.

The premium tax credit was temporarily enhanced in 2021, allowing Marketplace enrollees to lower their monthly premiums or claim a tax break when filing their return. The legislation covered 2021 and 2022, and lawmakers extended the benefit through 2025.

Younger retirees can benefit from lower premiums on the marketplace by leveraging their earnings, but some may be subject to a "phantom tax" when their income rises, according to Tommy Lucas, a certified financial planner and enrolled agent at Moisand Fitzgerald Tamayo in Orlando, Florida.

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"Lucas cautioned that several financial moves in retirement could affect the worth of these valuable credits, so "you have to be extremely careful.""

How the premium tax credit works

The American Rescue Plan Act temporarily removed income limits and capped premiums at 8.5% of income for households with income between 100% and 400% of the federal poverty level before 2021.

Determining eligibility for premium tax credit involves calculating the difference between a benchmark premium, which is the cost of the second-lowest-cost silver plan in an area, and a maximum contribution based on a percentage of income.

CFP Jim Guarino, managing director at Baker Newman Noyes in Woburn, Massachusetts, advised that any changes in reporting circumstances should be reported immediately to make necessary adjustments.

Your Marketplace premiums are reconciled on your tax return, so it's important to pay them accurately.

Common premium tax credit issues

Eligible younger retirees can save hundreds or even thousands per year with the premium tax credit, but higher income can reduce or eliminate eligibility, experts advise.

Claiming Social Security at age 62 has a significant impact on eligibility for the premium tax credit, as the entire payment, including the nontaxable portion, is taken into account, according to Lucas.

It is generally more advantageous to wait until age 65 to claim Social Security if you plan to claim the premium tax credit, according to him.

Roth individual retirement account conversions can result in the same issue as boosting income by transferring pretax or nondeductible IRA funds to a Roth IRA for future tax-free growth.

You could still implement the strategy later even if there are several years until required minimum distributions, Lucas stated.

"The goal is to minimize taxes throughout your entire life, not just for a short period of time," he stated.