Health Insurance Premium Tax Credit

If your household income is below a threshold amount, you may qualify for a federal tax credit to help you pay for health coverage. The credit can be applied throughout the year to the cost of premiums by having them paid directly to the plan; you don't have to wait until you file your income tax return to receive the benefit of the credit. If you qualify, the credit effectively limits the cost of premiums to a percentage of your household income (there's a sliding scale, which can be adjusted annually).

The credit applies only if you buy coverage through a government exchange and you do not have access to affordable coverage through another program, such as an employer plan. Income limits are based on the federal poverty level for the number of people in the household. The credit is a sliding scale teed off these limits, so that a person may qualify for small credit while others receive a larger one. More specifically, individuals and families who make between 100% and 400% of the federal poverty level (FPL), based on modified adjusted gross income (MAGI), meet the income limit for the credit. In Table 8.1 you'll see the federal poverty levels for purposes of the credit in 2019 and 2020. The 2018 FPLs are for the 2019 credit; the 2019 FPLs are for the 2020 credit. The amounts in the table are for the 48 contiguous states and the District of Columbia. The rates for Alaska and Hawaii can be found at the U.S. Department of Health and Human Services at https://aspe.hhs.gov/poverty-guidelines. If income changes during the year, the credit is adjusted accordingly.

Spousal Coverage

If your spouse works for a company that offers employee health coverage that can include you as the spouse of an employee, you're in luck. Usually, the premiums for coverage in a group plan are more affordable that obtaining coverage on your own.

Your spouse's employer may pay some or all of the coverage. For example, the employer may pay the cost of coverage for an employee but require the employee to pay the cost of family coverage. Thus, the cost of your coverage may be modest; the tab for your spouse's coverage may be picked up by his or her employer. Check with the plan administrator.

COBRA

If you are still working for an employer that has group health insurance and more than 20 employees, you can opt to continue under the group plan when you leave the company. Coverage can continue for up to 18 months after leaving the job. This coverage cannot be denied to a departing worker except in unusual circumstances, such as serious misconduct that triggered firing.

COBRA usually isn't free. You pay the premiums for the coverage, plus an administrative fee of up to 2% (that is, 102% of the premiums). In some cases, an employer will pay for COBRA for a limited time as part of a severance package if you are laid off. The employer payments may continue, for example, for three or six months, after which you must pay the cost yourself.

You must decide whether to opt for COBRA within 60 days of leaving employment. The plan's administrator will provide details, including any paperwork you must complete to arrange for coverage and payment.

Medicare and TRICARE

Federal health plans for certain classes of individuals may be helpful if you fall within the class.

Health Insurance Marketplaces

Even though the individual mandate under the Affordable Care Act has effectively been eliminated by the repeal of the penalty for failing to carry minimum essential health coverage, the government marketplaces continue to operate. Some states have their own marketplaces, while individuals in other states must look to the federal marketplace.

As a self-employed person with no employees, you are treated as an individual and must use the Individual Marketplace to shop for coverage. The Small Business Health Options Program (SHOP) is only for small employers with 50 or fewer full-time equivalent employees; it is not for self-employed individuals.

Information about health insurance plans for 2020 becomes available near the end of October 2019. Open enrollment for the individual marketplaces for 2020 began November 1, 2019, and runs through December 15, 2019. You can find more about these exchanges, including a link to what's happening in your state, from HealthCare.gov.

Other Health Plan Options

The whole arena of health coverage is in a state of flux, and new health care plan options may come your way. For example, in 2018, the federal government approved Association Health Plans (AHPs), which allowed trade groups and chambers of commerce to offer health care at group rates to their members. However, a federal court has put the status of AHPs on hold, at least for now. At the time this book went to press, the U.S. Department of Labor had appealed the adverse court ruling invalidating AHPs. What will happen to them in the future? Who knows?

Eligibility

You can opt for an HSA on the first day of any month in which you are covered by a high-deductible health plan (explained ahead) and do not have any other health plan, other than workers’ compensation, long-term care, disability, and vision and eye care. You cannot use an HSA once you enroll in Medicare.

Each spouse determines eligibility separately. The fact that your spouse may be ineligible for an HSA because he has employer coverage through his job does not mean you are not eligible for an HSA.

A high-deductible health plan (HDHP) is one that has certain minimum deductibles and limits on out-of-pocket costs for deductibles, co-payments, and other amounts, but not premiums. Table 8.2 shows these amounts for 2019 and 2020; these amounts can be adjusted for inflation in the future.

Contribution Limit

You can contribute to the HSA each year in which you have HDHP coverage. The deduction for the contribution is an adjustment to income on Schedule 1 of Form 1040 or 1040-SR; it is not a business deduction. Table 8.3 shows you the contribution limits for 2019 and 2020; these limits will be adjusted for inflation in the future.

HSA Strategies

You may be able to make a full-year deductible contribution to the HSA even though you aren't covered by an HDHP for the full year. As long as you are covered by an HDHP on December 1 and remain in an HDHP for at least 12 months, you can make a full-year contribution for the year starting December 1.

You have until the due date of the tax return for the year of the contribution, without extensions, to fund your HSA. This means you can make your 2019 HSA contribution up to April 15, 2020, the due date of the 2019 income tax return.

The money you save in an HSA can provide a nice financial cushion to you. You can use your HSA money for any reason at any time. If you take withdrawals for purposes other than paying qualified medical expenses not covered by insurance, the withdrawals are taxable. And, if you're under age 65, these nonqualified withdrawals are subject to a 20% penalty.

You can change the financial institution with which you keep your HSA. This can be done only by making a direct transfer from one HSA to a new one. But just because you can make this type of transfer with an HSA, don't assume it is like an IRA; it isn’t. If you take a distribution from an HSA, it's out forever. You can't use a 60-day rollover to replace the withdrawal.

Eligibility

To take the deduction as an adjustment to income on Schedule 1 of Form 1040 or 1040-SR you must have business income at least equal to the cost of premiums and not have other health coverage. More specifically, you must have net earnings (profits) from the business from your sole proprietorship. Worksheet 8.1 shows you how to determine your deduction.

And, you cannot take the deduction for any month in which you are eligible to participate in any employer-subsidized health plan (including your spouse's) at any time during the month.

Types of Plans

You can treat as health insurance for purposes of this deduction any premiums you pay for Medicare Parts B, C, and D.

You can also include premiums you pay for long-term-care insurance (up to certain limits); such insurance provides certain coverage in the event of a chronic illness, if the policy meets certain tax law requirements, including that it is guaranteed renewable.

It is not clear whether you can treat COBRA payments as self-employed health insurance. But it appears that you can't treat your COBRA premiums as self-employed health insurance because your former employer and not you established the plan.

Savings Opportunity

You can contribute each year that your business makes a profit. The deductible contribution for a self-employed person in 2019 is essentially (but not exactly) capped at 20% of your profit, or $56,000, whichever is less. You don't have to add the maximum amount; you can add what you can afford.

Only a maximum amount of profit (e.g., $280,000 in 2019) can be taken into account in figuring your deduction. Before applying the 20% to your profit, reduce the profit by one-half of your self-employment tax. If you prepare your return by computer, all of these calculations are done automatically for you. But if you want to see in advance what you can contribute rather than waiting for software to figure your maximum contribution, use Worksheet 8.2.

You can contribute up to this maximum limit. But you are allowed to contribute a lesser amount, something you might choose to do if you cannot afford to contribute the maximum amount.

Making annual contributions is only one-half of the retirement savings equation. To optimize your returns you must invest the contributions wisely. To do this, use online tools offered by brokerage firms and mutual funds for this purpose. The tools and information explain such financial strategies as diversification and repositioning investment holdings. Also consider working with a knowledgeable financial advisor.

Make it your business practice to review your plan's performance and make changes in your investment portfolio when needed. Do this review at least annually; quarterly is even better. Check with your plan to learn about any restrictions you face on changing investment holdings in the plan.

Other Rules for SEPs

SEPs provide great flexibility to you. The plan can be set up and funded up to the due date of the return, including extensions. Thus, if you need time to figure your profit for the year, you don't have to create the plan or add money until you file your return.

Savings Opportunities

The law sets limits on how much you can put into the solo 401(k) plan each year. Again, you don't have to add the maximum. The contribution is made up of what would be an employee contribution (if you were an employee) and an employer contribution (if you were an employer). The contributions effectively shelter your profits.

The limits can change annually. Just to give you some idea of how much you can save for retirement using a solo 401(k), the limits for 2019 are:

• Employee contributions up to $19,000, plus another $6,000 if you're at least 50 years old by the end of the year.
• Employer contributions that bring total contributions up to $56,000 (or $62,000 if you're at least 50 years old by the end of the year).
• No more than $280,000 of profit can be taken into account in figuring your deductible contribution for the year.

Again, just making a contribution won't guarantee you a secure future. It's up to you to choose how your contribution is invested and to monitor investment activities so you can make changes when warranted. Be sure to understand your investment options and how often you're permitted to make changes in your account. If you need help, talk with a financial advisor.

Designated Roth Accounts

Instead of using tax deferral to build retirement savings by making deductible contributions, consider waiving the current benefit of the deduction for the future benefit of tax-free income. Your solo 401(k) can have a Roth component that lets you set aside funds on an after-tax basis; the earnings on these contributions can become tax free. The same basic rules apply for making contributions to the designated Roth account, which means you still have to show a profit.

If the plan allows, you can designate some or all of the “employee” contributions to the Roth component. You are taxed currently on the profits designated for this purpose. No “employer” contributions can be added to the Roth component.

Using a designated Roth account isn't an all-or-nothing proposition. You can put some funds into the Roth component and the balance into the traditional 401(k). Once you make the designation for contributions, it is permanent and cannot be changed. You can base matching “employer” contributions on the Roth component, but the matching contributions don't go into the designated Roth account; they are part of the traditional 401(k).

Other Rules

Contributions to solo 401(k)s are based on your profit for the year, something you may not know until your year closes. The law allows you to make contributions for the current year after the year has ended. However, the plan must be set up by the last day of the year to which contributions relate. Setting up the plan means signing paperwork for this purpose with a financial institution, such as a brokerage firm or mutual fund company, that will act as trustee for your plan.

You may have to submit annual information returns to the U.S. Department of Labor's Employee Benefits Security Administration (EBSA). If the only participant in the plan is you (or you and your spouse), you can file Form 5500-EZ, Annual Return of One Participant (Owners and Their Spouses). No form is due if the value of plan assets at the end of the year do not exceed $250,000 (unless it is the final year of the plan where the form is due regardless of the amount of plan assets). The return is due on the last day of the seventh month after the close of the plan year (e.g., July 31, 2020, for a 2019 plan based on a calendar year). If you are delinquent in filing the form, you can be subject to penalties. However, you may be eligible for penalty relief by following IRS procedures, the details of which can be found at https://www.irs.gov/retirement-plans/penalty-relief-program-for-form-5500-ez-late-filers.

If you obtained an automatic 6-month filing extension for your personal income tax return, you automatically have until October 15 to file Form 5500-EZ. Be sure to attach a copy of your personal filing extension to this form. If you didn't obtain a filing extension for your Form 1040 or 1040-SR but still need more time to file Form 5500-EZ, request a 2½-month extension on Form 5558, Application for Extension of Time to File Certain Employee Plan Returns.

You don't have to file the form with EBSA if plan assets do not exceed $250,000 at the end of the year (and it's not the final plan year). Because the value of the account can vary from year to year, don't assume that not filing the return in one year automatically exempts you in the following year; check the year-end statement of the plan.

Because you are the only person in the plan, there is simplified reporting. You don't have to file electronically, but can choose to do so. Find information about filing Form 5500-EZ from the IRS at https://www.irs.gov/pub/irs-pdf/i5500ez.pdf.

Other Rules

The deduction for contributions to an IRA is not a business deduction. Instead it is an adjustment to gross income on Schedule 1 of Form 1040 or 1040-SR. The contribution can be made up to the due date of the return without regard to extensions. For example, a 2019 contribution can be made by April 15, 2020, regardless of whether you obtain a filing extension.

As mentioned earlier in this chapter, funds in your IRA usually can't be tapped without a penalty before you reach age 59½. There are some exceptions to the penalty, such as paying medical expenses, education costs, and first-time homebuying expenses. You can also use the funds penalty free before age 59½ if you become disabled. However, there is no exception to the penalty for financial hardship or starting a business.

As in the case of SEPs and 401(k)s, the funds you'll have from your IRA depend on the performance of your investment choices. Monitor your account and, if you want, work with a knowledgeable investment advisor to help maximize your savings.

Work with a Financial Planner

Set the goals you have for retirement as you would set goals for your business. Decide on whether or when you anticipate retirement. Project what you expect to need for retirement income.

Maximize Contributions

The sooner you start to save, the better off you'll be because time is on your side. Even small contributions made when you are young can grow to impressive amounts over a long time horizon. While you may have many other demands on your limited funds, such as growing your business, buying a home, and raising a family, don't forget to budget for retirement savings.

If you are older, consider using the type of retirement plan that will allow for significant savings, such as a pension plan. And even if you aren't saving sizable sums at this time in your life, at least you're segregating funds for retirement and won't spend them on other things.

Put your retirement savings on automatic pilot. While the tax law gives you plenty of time to make your annual retirement plan contributions, it may be easier from a cash flow perspective to make more modest contributions on a regular (say monthly) basis. Add retirement savings to your monthly budget and then transfer funds to your retirement account at a fixed date each month.

Cover Your Spouse

To grow the retirement savings for your household, consider putting your spouse to work in your business. You gain valuable help in your business and increase the retirement savings for your family. For example, a self-employed individual owns a company that installs security systems for homeowners. His spouse, who is his employee, stays at home, taking calls from customers, scheduling appointments, and keeping the books. Contributions to a retirement plan can be made for the employee-spouse.

Before you take such action, make sure that there is work for your spouse and that wages paid to your spouse are reasonable in light of the work being done. Also compare the payroll costs of hiring your spouse with the savings opportunities through a retirement plan.

Minimize Distributions

With retirement plans, other than Roth IRAs, at some point the game is up. You must start drawing down the account by taking required minimum distributions (RMDs) or face a 50% penalty. However, you can use strategies to help you minimize your tax exposure while maintaining your retirement savings.

• For IRAs, take withdrawals from low-yielding accounts. If you have multiple IRAs, you can add account balances and then take your RMD from one or more accounts. You cannot use this strategy for qualified retirement plans; RMDs must be taken from each plan you participate in, including plans in which you participated with an employer prior to self-employment.
• Continue to fund qualified retirement plans despite taking RMDs. SEPs, Roth IRAs, and other plans have no age limit on contributions; only traditional IRAs do (and Congress is thinking about eliminating the age cap on traditional IRA contributions).