Client Service May 5, 2020

Planning for Clients’ Health Care Expenses in Event of a Layoff

Mark Waterstraat, president of consumer solutions at Alegeus, offers simple steps to coach clients through managing their health care finances after a layoff. For example, did you know that individuals can use HSA funds to pay COBRA premiums tax-free?
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The COVID-19 pandemic has left 30 million Americans unemployed and many people are questioning what to do next when it comes to their finances.

Given the heightened health risk of the pandemic, continuing health care coverage plays a major role in these decisions. Here’s what advisers can do to educate their clients about their options and guide them to make the best choices as they transition into unemployment.

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Ask About Health Care Needs

Employer sponsored health plans have defined rules that govern when health insurance coverage will end once employment ends. Sometimes coverage ends on the last day of employment, but for most clients, coverage will continue through the end of the month in which they were laid off. After that, they have decisions to make, and advisers can help them explore the right next move that weighs their health care needs against the cost for that coverage.

Those with fewer anticipated health care needs or those who have significant savings in a health savings account (HSA) may feel comfortable exploring the Patient Protection and Affordable Care Act (ACA) marketplace or other increasingly popular concierge or direct-care services. Others with chronic conditions that require frequent care or who need more comprehensive coverage will want to consider continuing their employer-sponsored coverage under COBRA [Consolidated Omnibus Budget Reconciliation Act].

The Benefits of COBRA

In normal times, only a small percentage of individuals eligible for COBRA actually enroll. This is typically due to confusion around enrollment and the high premium cost, which may feel too expensive for those now without a regular source of income.

Advisers should be prepared to point out the important COBRA benefits that potentially outweigh the premium cost. These include the following:

  • Continuity of care. Those with chronic conditions or who otherwise receive frequent care may save money in the long run by continuing comprehensive employer-sponsored coverage under COBRA. Further, if they have a physician or hospital relationship that would change with new insurance coverage, COBRA allows them to maintain crucial and trusted care.
  • Fast short-term protection. COBRA is the simplest and quickest option to ensure people have health care coverage, especially during a higher-risk time such as a pandemic. Researching and enrolling in a marketplace plan may not be worth the effort, especially if clients have reason to believe their coverage gap will last only 30 to 90 days before getting back to work.
  • Additional assistance may come in multiple forms. There are a few instances where COBRA premiums may be subsidized. While they are not required to do so, some employers subsidize a portion of the premium cost for a period of time after a layoff. It is also possible that in the coming weeks or months, the government will announce subsidies for COBRA like those issued during the Great Recession. And lastly, consumers can use HSA funds to pay COBRA premiums tax-free.
  • Special considerations come into play. For people who had a high-deductible health plan (HDHP) and already met most or all of their deductible for the year before being laid off, COBRA could be the best option because their out-of-pocket costs for qualified medical expenses for the rest of the year will be greatly reduced. In fact, under many plans, they may be $0. If an individual doesn’t elect COBRA, they may need to start over with a new plan and a new deductible.

What About Flexible Spending Accounts?

People with a flexible spending account (FSA) should consider enrolling in COBRA to protect the money they’ve contributed tax-free into the account. Without continuation of coverage, any unspent dollars in the account will be forfeited to the employer when the health insurance is canceled.

People usually have 60 days from the time they receive an election notice or when coverage ends to enroll in COBRA, but the IRS and Department of Labor (DOL) recently extended the enrollment period, given the extenuating circumstances of COVID-19. Additionally, people have 45 days from the date of their election to pay for the coverage. This means that an individual (who does not need immediate health care services) can take up to 105 days to decide.

Consider, however, that the special enrollment period for marketplace insurance through the ACA is only 60 days. Those who wait to make a decision based on the COBRA deadline could miss their opportunity for marketplace insurance altogether.

Every client will have drastically different needs and scenarios. Helping them understand their health care coverage options after a layoff will ensure they stay healthy while looking out for their overall financial health, too.

 

Author’s note:

Specific guidance or requirements are not explained in detail here and always require research and education. These explanations are not exhaustive in nature.

Editor’s note:

This feature is to provide general information only, does not constitute legal or tax advice, and cannot be used or substituted for legal or tax advice. Any opinions of the author do not necessarily reflect the stance of Institutional Shareholder Services or its affiliates.

The Markets April 30, 2020

The Coronavirus Crash Tax Diversification Opportunity

Every cloud has a silver lining. One opportunity presented by the recent market volatility caused by the coronavirus pandemic is the chance to create greater tax diversification in retirement portfolios.
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Art by Jonathan Muroya


Susan Czochara is practice lead of the retirement solutions group at Northern Trust Asset Management, a role in which she is responsible for the development and distribution of investment solutions and research content designed for the retirement market.

Czochara sat down recently for a (remote) discussion with PLANADVISER about one of her firm’s most recent analyses, which highlights an important silver lining tied to the market turbulence caused by the ongoing coronavirus pandemic.

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“At the time of this conversation, it has been exactly one month since I was last in our office in person, and I was actually the only one on the office floor that day because I had to do something in person,” Czochara recalls. “At the time it was already such a different world we were entering, and over the last month we have continued to see some dramatic swings in the equity markets.”

The swings have been painful for retirement plan investors and individual retirement account (IRA) holders, but one positive note, Czochara says, has been the opportunity to think about getting some tax diversification into one’s investments.

“One of the biggest benefits of consideration of Roth accounts is to create tax diversification in a retirement portfolio,” she explains. “Especially for those younger investors who are a long way from retirement, it’s actually very difficult to anticipate what the tax situation is going to be when they actually retire.”

The common wisdom is that taxes in retirement will be lower because of lower stated income.

“However, if you look at where we are today in terms of where income taxes are, they are lower than many historical periods,” Czochara notes. “In that sense, there is actually a pretty good chance the rates could rise. That fact supports the importance of utilizing Roth in combination with traditional accounts. It helps you prepare for the unknown tax future and to have greater flexibility for future withdrawals.”

The reason why now is probably a good time to do a Roth conversion is the simple fact that asset values are down substantially relative to recent highs. That means the income tax paid on the converted assets will also be substantially lower. Once markets rebound, the assets will then be in a pre-taxed account, meaning they can be drawn tax-free down the road.

An Opportunity Clearly Overlooked

A recent Issue Brief publication penned by Craig Copeland, senior research associate at the Employee Benefit Research Institute (EBRI), offers some informative context for the Roth conversion conversation.

According to Copeland’s analysis, there appears to be relatively little sophistication in the marketplace when it comes to efficiently coordinating the withdrawal of tax-deferred versus pre-taxed assets among U.S. retirees.

“Traditional and Roth individual retirement accounts have different withdrawal and taxation rules,” Copeland observes. “Traditional IRAs can receive deductible or nondeductible contributions, but any gains accrued in the account are taxable at withdrawal at the prevailing income tax rate. In addition, owners of traditional IRAs are required to start making withdrawals once they reach a certain age, generally 72 for those who marked their 70th birthday on July 1, 2019, or later.”

In contrast, Roth IRAs only allow nondeductible after-tax contributions, and withdrawals are generally not subject to taxation. Furthermore, owners of Roth IRAs are not required to make withdrawals.

“Consequently, those owning both IRA types could pursue withdrawal strategies that take advantage of the variations in tax rules—for example, withdrawing from one account type sooner than the other,” he explains.

In reality, the EBRI IRA Database shows, traditional IRAs are clearly the favored source of withdrawals. Copeland says this is true even for those in age cohorts that do not require minimum withdrawals.

“For example, while IRA owners ages 60 to 64 were more likely to use some combination of the IRAs for their withdrawals, they typically only took one withdrawal from their Roth IRA over time, with the remaining withdrawals coming from the traditional IRAs,” Copeland says. “Owners of IRAs with the largest balances who took withdrawals each year within the study were among those least likely to take their withdrawal from a Roth IRA, despite being the individuals likely to have the most to gain from taking withdrawals to minimize taxes.”

EBRI’s analysis shows there was also “little evidence that owners deplete or close one account type before withdrawing from another.” Again, simply put, the account type most likely to be depleted or closed was the traditional IRA.

“Current retirees do not appear to be taking advantage of the different tax regimes of the two IRA types in their withdrawal strategies,” Copeland says. “Instead, they are for the most part preserving their Roth IRAs. … A more widespread understanding that the source of withdrawals taken from IRAs can have an impact on the dollars available for everyday uses could have beneficial effects for many retirees.”

A Lasting Opportunity

The EBRI numbers are somewhat disappointing, but as Czochara observes, the significant market volatility anticipated for the next several months or even years makes this a great time for financial advisers to double down on their tax diversification messaging.

“When account values have dropped, as they have in the first quarter, you will be paying less in income tax on the amount that is converted than you would in normal times,” she says. “That being said, this isn’t an easy strategy for every retirement investor, because there is income tax due when you do the Roth conversion. For many people right now, short-term funding needs are taking precedence, and so it may be a difficult time right now to do the conversion.”

Advisers can therefore take this time to educate their clients about their future conversion opportunity.

“There may be a period some months or years down the road when the stars do align for clients to take advantage of this strategy,” Czochara says. “There is also the opportunity to do partial conversions over a period of several years to help ease the income tax burden. One warning I will conclude with is that, for any investor that is considering a Roth conversion, if you don’t have the liquid cash on hand to pay the income taxes, you really should not tap your existing retirement assets to do it. That is a clear indication that a Roth conversion is not appropriate at this time. You have to plan what assets are going to be available for this strategy.”

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