Does It Cost Less to Buy Health Insurance or Pay the Tax Penalty?

Image © Lisa Marzano

In the United States, if you don’t have health insurance, you’ll face a tax penalty.  It’s the carrot-and-stick approach the Affordable Care Act takes to getting U.S. residents to buy and maintain health insurance coverage.

The carrot part offers government subsidies to help people with modest incomes pay their monthly health insurance premiums. The stick part, brought about by the ACA’s individual mandate, is a tax penalty for going without health insurance.

It’s known as the individual shared responsibility payment.

The individual mandate leaves you with a choice: get health insurance coverage or pay the tax penalty for being uninsured. Although there are many reasons why it’s wise to have health insurance, for some people the choice will be made on the basis of cost alone. Does it cost less to buy health insurance or to pay the tax penalty?

There are two answers to this question. The simple answer is based solely on health insurance premiums and tax penalty amounts; the complicated answer takes the big picture of your entire budget into account.

Which Costs Less? Health Insurance Vs Pay the Tax Penalty—the Simple Answer

The tax penalty is likely to cost less than health insurance as long as you don’t qualify for a health insurance subsidy to make the cost of buying health insurance more affordable. If you qualify for a subsidy, your cost to buy health insurance could be much lower.

The tax penalty is either a fixed minimum amount or a percentage of your income, whichever is larger. Low income people pay the fixed minimum amount; high income people pay a percentage of their income.

However, those required to pay a percentage of their income are protected financially by an upper limit on the penalty.

The maximum penalty amount is equivalent to the national average cost for a bronze-tier health plan that year.

Since bronze-tier health plans are generally the lowest-cost plans that will satisfy the mandate to have health insurance and avoid the penalty, the highest possible penalty you’ll pay is about the same as the cost of a “cheap” health insurance plan.

Even the IRS doesn’t want your penalty to cost more than buying health insurance would have cost:

…to help ensure that individuals subject to the limitation on the amount of the individual shared responsibility payment are generally not liable for a payment that materially exceeds the individual’s actual cost of coverage, the monthly national average bronze plan premium is based upon the premium charged to individuals aged 21. (IRS Revenue Procedure 2014-46.)

Health insurers are allowed to charge older people up to three times more for health insurance than they charge 21 year olds. If you’re significantly older than 21, health insurance will cost you more than it costs your 21 year old neighbor.

However, your penalty is still capped at the national average price for a 21 year old buying a bronze plan, making it even more likely that paying the penalty  will cost less than buying unsubsidized health insurance will.

However, most people paying the tax penalty for being without health insurance won’t need to rely on the penalty cap. Since the penalty is based on your income, if you have a modest income, your tax penalty won’t be high enough to reach the cap.

An Example Comparing the Cost of Health Insurance to Paying the Penalty for Being Uninsured

Let’s say you’re a single person who made $80,000 in 2016. Your shared responsibility penalty would be 2.5% of your income or approximately $1,750.

Not sure how I came up with those figures? Learn to calculate the tax penalty yourself in “How Much Is the Health Insurance Penalty for an Individual?” and “How Much Is the Health Insurance Penalty for a Family?

Since the national average cost for a 2016 bronze health plan hasn’t been released as of the publication date of this article, we’ll use the 2014 cost: $204 per month or $2,448 per year. This is about $700 more than the penalty a single tax filer making $80,000 would pay.

If you make less than $80,000 per year, the penalty would be lower than $1,750 making the cost difference between paying the penalty and buying health insurance even greater.

Buy Health Insurance Vs Pay the Tax Penalty—the Real Costs

Although chances are good that the tax penalty will cost less than unsubsidized health insurance premiums, it may be a smarter financial move to buy the health insurance. Why? Because health insurance affects your health care expenses which can impact your overall budget.

Depending on how much you spend on health care expenses and the health insurance plan you buy, having health insurance might lower your health care expenses enough to tip the financial scales in favor of health insurance vs paying the penalty for being uninsured.

Those with higher health care expenses, chronic illnesses, expensive prescription medicines, or frequent doctor visits are more likely to see health insurance impact their budget’s bottom line favorably. Those with little need for health care services may not see as favorable an impact on their overall budget.

Learn how to figure out the overall budget impact of buying health insurance versus paying the tax penalty in, “Buying Health Insurance Vs the Paying the Penalty: Doing the Math.”

I’m an RN who specializes in health insurance. I believe that having health insurance coverage is generally a wise choice. I’m not a financial planner, CPA, or other financial professional. As such, the information presented in this article shouldn't be considered financial advice. Seek the advice of an accountant or financial planner before taking action.

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