Analysis: Medicare and Social Security

The recent annual trustee reports on Medicare and Social Security, despite some positive headlines, actually tell a very different story in their details. Both programs are likely to face significant challenges in the coming decade, necessitating reforms that will likely impact our clients – some significantly.

Medicare

Medicare’s financial situation remains unsustainable, both in the short and long term. Clients should incorporate into their planning cash supplements to Medicare in retirement.

In this year’s report, Medicare’s trustees analyzed that Medicare should remain financially in the black through 2029, a 12-year improvement over last year’s estimate. They credited the healthcare reforms carried out by Congress and the Obama administration, citing greater efficiency that would translate to savings for the program.

The report indicates that, with the projected $192 billion in cuts to Medicare Advantage plans, home health care and hospitals across the next ten years, both the 75-year shortfall for its hospital fund and projected costs of the Medicare Supplementary Insurance program will shrink.

However, these projections are based on assumptions of cost savings and reductions in doctor compensation that Medicare’s Actuary, Richard Foster deems unlikely in his official supplement to the trustees report. We agree.

Regardless of where the cost savings come from, the net result is that Medicare will continue to service a growing population and the result of cost savings will mean longer lines, less access to physicians, and increased bureaucracy in accessing benefits.

Accordingly, we expect that upper middle and wealthier clients will increasingly depend on “concierge medicine” (which will become less of a boutique service), where they will pay physicians directly for services not covered by Medicare, or for which the quality or wait times are inadequate and either be reimbursed or which they will pay for directly. Indeed, we fully expect this model will become the primary model of health care for the upper end of incomes at all age levels.

Recent political and level make it now quite possible that the congressional mandate to purchase health insurance will fail political and constitutional tests and the net result is that Medicare tax revenue will be required to supplement health care costs.

Accordingly, an increase in Medicare taxes through FICA seems increasingly likely – although by no means guaranteed due to strong Republican and “Blue Dog Democrat” opposition to the overall health care plan.

In response, we’re now recommending that clients budget an additional $6,000-12,000 in uncovered medical expenses annually in retirement.

Social Security

In 2010, Social Security is paying out more than it is taking in – and by previous federal estimates, that wasn’t supposed to happen until 2016. According to government forecasts, it can continue using payroll taxes and interest income to cover benefits until 2024.

The projection that Social Security’s accumulated surplus will run dry in 2037 is unchanged. After 2037 (assuming things don’t change), Social Security’s program revenues would only cover about 75% of its expenses – so payroll taxes would have to increase, or benefits would have to be scaled down.

We anticipate that a reform of the Social Security system will likely come in the next few years, and that it is likely to result in again pushing the minimum retirement ages into the mid-60s, with the full benefit being available at age 70. It seems likely this will be imposed on individuals younger than age 55, with some type of “phase in” of the changes.

Social security benefits are likely to be means tested by income at some point as well, resulting in some type of reduced benefit to higher income earners, although it’s likely that this will be phased in gradually and only effect those under age 50.

Our analysis of the program’s history and the policy literature leads us to expect that the amount of income taxed (covered) by social security should increase from its current $106,800 level to approximately $210,000 a year. This effectively means that clients can anticipate an additional 4.75% taxation of their salary incomes (as well as the new tax on investment income in the health care reform legislation), up to an additional $5,000 a year.

In response, we’re anticipating higher tax rates on salary incomes starting in 2012 for all new financial analyses.