As safety net shrinks, medical costs will grow

Let’s face it— Congress will do nothing to address the nation’s financial problems this year before the elections, and probably not in the lame-duck session immediately afterward. But when the new Congress convenes next

year, it must quickly tackle both the short-term federal deficit and the long-term debt crisis that is looming as the nation’s debt-to-GDP ratio rapidly approaches 100%.

We still believe that the report of the Simpson-Bowles Commission provided an excellent starting point for addressing both the short-term and long-term problems.

Once solutions to those problems are in place, Congress must turn its attention to two other thorny obstacles — those relating to Social Security and Medicare.

As the most recent report of the Social Security System trustees stated, the Social Security Trust Fund will be exhausted by 2033, three years earlier than forecast previously. After that, the Social Security Administration will be able to pay only 75% of the promised benefits to retirees.

That means anyone 21 years or more from retirement could receive less from Social Security than they now expect.

EFFORTS TO PREPARE

As reported in last week’s issue of InvestmentNews, many financial advisers are helping clients prepare for possible future cuts in their Social Security benefits, and devising strategies to make up for that possible loss of retirement income.

Should Congress surprise us and take action to fix Social Security, those who have taken steps to reinforce their non-Social Security income will simply be better off.

There are many possible solutions to the problem of funding Social Security. First, the payroll tax funding the trust now applies to only about 84% of the nation’s total employee earnings because income above $110,000 a year is not subject to it. Raising the income level subject to the tax to 90% of total earnings (making an individual’s taxable income $180,000) would fill about one-third of the gap.

There are also suggestions that Social Security benefits should be means tested so that high-in-come earners would receive reduced benefits, and the retirement age could be raised gradually, as it was in the reforms undertaken in 1983, during the first Reagan administration.

The idea of means testing Social Security benefits — reducing what high earners receive — is opposed by some experts because it would make Social Security simply another income transfer or welfare system.

On the other hand, some oppose increasing the retirement age for all workers because the life expectancy of 65 has increased by only one and a third years for low-income men, while it has increased by six years for men on the top half of the income ladder. The equivalent data for women are not available.

Having addressed the possible changes to Social Security, financial advisers should turn their attention to medical costs in retirement. The Medicare trust funds are in worse shape than the Social Security Trust Fund. According to the latest trustees’ report, the Medicare trust funds will run out of money in 2024, after which they will be able to pay only 87% of scheduled hospital benefits to retirees.

OVERLY OPTIMISTIC

Some critics say that even expecting the Medicare trust funds to avoid depletion until 2024 is optimistic because the trustees relied on unrealistic assumptions — e.g., that Congress will allow a 31% cut in payments to doctors for services rendered to Medicare recipients, a provision of the health care reform law, to go into effect. Congress has not allowed previous scheduled cuts to take effect.

Even if Medicare is repaired, an average couple retiring at 65 will need to set aside $230,000 just to pay for medical costs (including Medicare and Medicare supplemental premiums) in retirement, assuming a life expectancy of 85 for women and 82 for men, according to a study by Fidelity Investments. The Employee Benefit Research Institute estimates that to be 90% sure of covering those expenses, a couple needs to set aside $271,000. That’s a substantial sum.

Financial advisers have their hands full in trying to position clients to handle the likely, though at present inscrutable, changes ahead for Social Security and Medicare, but they also should be making provisions for their clients to deal with these, and possibly even greater, medical costs in retirement.