Do 401k Withdrawals Count as Income for Obamacare?

Understanding how different income sources affect your eligibility for Affordable Care Act (ACA) subsidies is part of managing healthcare costs. Many people, particularly those approaching or in retirement, question if taking money from a 401(k) plan will impact their eligibility for these subsidies.

How ACA Subsidies Are Calculated

The Affordable Care Act provides a subsidy called the Premium Tax Credit (PTC) to help individuals and families afford health insurance purchased through the Health Insurance Marketplace. Eligibility for this credit is not based on your gross income, but on a specific figure called Modified Adjusted Gross Income (MAGI).

Your MAGI starts with your Adjusted Gross Income (AGI), which is calculated on your federal income tax return. AGI includes wages, salaries, self-employment income, and other forms of taxable income, minus certain deductions. To get from AGI to MAGI for ACA purposes, you must add back certain types of income that are not taxed, such as untaxed Social Security benefits, tax-exempt interest, and foreign earned income.

The Health Insurance Marketplace uses your projected household MAGI for the upcoming year to determine the amount of subsidy you can receive. This subsidy is structured to cap your health insurance premium as a percentage of your income, based on the Federal Poverty Level (FPL) for your household size.

While subsidies are most significant for those with lower incomes, eligibility has been expanded. Now, even households with incomes above 400% of the FPL may receive assistance if their marketplace health insurance premium would be more than 8.5% of their household income. The lower your MAGI, the higher your potential subsidy.

Taxable Status of 401(k) Distributions

The tax treatment of money withdrawn from a 401(k) plan determines whether the funds will count as income for ACA subsidy calculations. The most common type is a traditional 401(k), funded with pre-tax contributions. Consequently, distributions from a traditional 401(k) are fully taxable as ordinary income in the year you receive them.

In contrast, a Roth 401(k) is funded with after-tax dollars. As a result, qualified distributions from a Roth 401(k) are tax-free. For a distribution to be qualified, you must be at least 59½ years old and have held the Roth account for a minimum of five years.

It is also important to distinguish distributions from loans. Taking a loan from your 401(k) is not a taxable event and does not count as income, provided you adhere to the loan’s repayment terms. If you fail to repay the loan, the outstanding balance will be treated as a taxable distribution.

For those under age 59½, taking a distribution from a traditional 401(k) incurs a 10% early withdrawal penalty on top of the regular income tax. The penalty does not change the fact that the entire withdrawal amount is considered taxable income for MAGI calculations.

Connecting 401(k) Withdrawals to Your MAGI

The taxable portion of any 401(k) distribution is included in your AGI. Since AGI is the starting point for calculating MAGI, any taxable withdrawal from a retirement account will increase your MAGI by the same amount.

For example, if you withdraw $20,000 from a traditional 401(k), that full $20,000 is considered taxable income. This amount is added to your other income sources, directly raising your AGI and, subsequently, your MAGI. This increase could be enough to reduce your subsidy or push you over an eligibility threshold.

Conversely, a qualified withdrawal from a Roth 401(k) has no effect on your MAGI because the distribution is tax-free and not included in your AGI calculation. This makes Roth accounts a useful tool for managing income without jeopardizing health insurance subsidies.

A direct rollover of funds from a 401(k) to another qualified retirement account, such as an Individual Retirement Arrangement (IRA), is not considered a taxable distribution. The money is not reported as income and does not affect your MAGI.

Reporting Withdrawals for the Health Insurance Marketplace

When applying for Marketplace coverage, you must estimate your annual household MAGI, including any planned 401(k) withdrawals. The Marketplace uses this estimate to calculate the amount of advance premium tax credit you can receive each month to lower your premiums.

If your financial situation changes during the year, you must update your income information with the Marketplace. An unplanned 401(k) withdrawal is a significant income change that must be reported. You can report changes online through your HealthCare.gov account, by phone, or with an in-person assister.

When you update your income, the Marketplace will re-evaluate your subsidy eligibility. Your monthly premium assistance may be reduced or eliminated for the remainder of the year to align with your new, higher projected MAGI.

Reconciling Your Premium Tax Credit

When you file your annual federal income tax return, you must reconcile the advance premium tax credits you received with the actual credit you were eligible for based on your final MAGI. This reconciliation is done using IRS Form 8962, Premium Tax Credit.

On this form, you report your final MAGI, which must include the taxable portion of any 401(k) distributions. The form calculates the credit you were entitled to, which is then compared to the advance payments made on your behalf.

If the advance payments were less than the credit you were eligible for, the difference is added to your tax refund or lowers your tax liability.

If the advance payments exceeded your eligible credit, you must repay the excess amount. This is a common result if an unplanned 401(k) withdrawal raised your MAGI, and the repayment will either reduce your tax refund or increase your tax liability.

The IRS has repayment limits for households with incomes below 400% of the FPL. If your income is 400% of the FPL or higher, you must repay the entire excess amount.