What Will Happen to Social Security and Medicare?

What will happen to Social Security and Medicare?Each year the trustees of the Social Security/Medicare trusts are required to report on the status of the trust funds. Last month, having included the effects of the recession in their projections, they released a new report. The news is not good.

Last year’s analysis projected that Social Security would begin paying out more in benefits than it would collect in taxes in 2017.  This year’s report from the Trustees of the Social Security and Medicare trust funds concludes that given the levels of unemployment now included in their model, we’ll reach that point a year earlier, in 2016.  David Merkel at the Alephblog points out that if the economy remains weak for a couple of years, Social Security’s “break-even” could come as early as 2013.

Medicare, which had previously been expected to have its expenses exceed revenues in 2019, is now expected to reach break-even in 2017.  Last year, it was projected that in 2010 Social Securities receipts would exceed expenditures by $86 billion; in this year’s report the projected margin has narrowed considerably to $3 billion.  One-third of last year’s federal budget was for Medicare and Social Security expenditures; the proportion is projected to rise to 40% by 2019.

The trust funds, consisting entirely of non-marketable Treasury securities, don’t actually constitute money that can be spent.  Instead they are IOUs for funds that must be raised somehow.  I agree with David Merkel’s opinion that serious problems will start not when the trust funds run out, but long before, when breakeven occurs.  When the trust funds need to be spent, the Treasury will have to come up with more money, and there’s no easy way for that to happen.  David offers a number of possible solutions to the problem in his article, as well as links to other pieces he’s written on this problem.

In the absence of massive Federal spending cuts there are few ways to bridge the Social Security/Medicare benefit funding gaps.  Cuts in benefits, increases in the age at which benefits are available, further government borrowing, and higher taxes are the only major areas where solutions exist.

If the long-term funding problems of Medicare and Social Security aren’t credibly addressed, the pressure to do so will become intense even before break-even is reached.  The possibility of significantly higher borrowing levels will undoubtedly spook our foreign creditors, who already hold $3.2 trillion in Treasury debt. Aside from concerns about US creditworthiness, debtors will also worry that the government may seek to relieve its debt load through increased inflation.  Doing so would effectively stiff holders of long-term Treasury debt, who’d receive a smaller after-inflation return than expected.  Stanford economist John Taylor recently pointed out that the Congressional Budget Office projects a federal deficit of $1.2 trillion in 2019; he observes that this also will tempt the government to seek an inflationary solution.

Implications for Retirement Planning
When doing retirement projections, I usually assume that the Social Security benefit a client will receive will be 75% (or less) of the amount currently projected on his or her annual Social Security statement.  It seems certain that benefits will either shrink or be taxed at higher levels (or both).  I’m starting to doubt whether people under 30 should plan on getting anything at all from Social Security in retirement.

Medicare, which is in much worse shape than Social Security, is unlikely to survive in its current form.  Fidelity recently estimated that a couple retiring this year would need $240,000 in savings allocated for retirement health care costs.  Fidelity’s analysis assumed the continuation of current Medicare benefits, which is unlikely; the future costs for those who are younger will probably be higher.  In my opinion, anyone under 50 should plan for substantial health care insurance expenses in retirement.

About the author

Thomas Fisher, CFP®
Thomas Fisher, CFP®

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