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Mark Miller: Remaking Retirement

The Financial Health of Medicare and Social Security: A Closer Look

The short-term outlook for these programs has improved, but challenges and uncertainties loom.

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Forecasting the financial health of Social Security and Medicare brings to mind that old saying: “It’s tough to make predictions, especially about the future.”

The quip usually is attributed to baseball legend Yogi Berra, although it actually seems to originate with a Danish politician circa 1948. No matter the source, it’s a suitable comment when considering forecasts about our two most important retirement programs.

Two years ago, plenty of pundits were warning that the pandemic-induced economic plunge would blow huge holes in these two mammoth social insurance battleships. But reports issued this month by the trustees of the two programs show that the strong economic rebound last year contributed to slight improvements in the health of both Social Security and Medicare.

More people were working and paying Federal Insurance Contributions Act, or FICA, taxes last year. As a result, Social Security’s trustees forecast that the combined retirement and disability trust funds will be depleted in 2035—one year later than last year’s forecast. The Medicare trustees report that the Hospital Insurance, or HI, trust fund will be emptied in 2028—two years later than forecast last year. (A summary of both reports is available here.)

Still, both of those dates are too close for comfort—and long-term problems loom for both trust funds.

Think of these trust funds as checking accounts that receive FICA payments, other tax revenue, and interest income, and then use those funds to meet their obligations. The Social Security and Medicare trust funds are drawing down their balances; if they reach the point of exhaustion, they would be able to continue to pay benefits from current receipts, but cuts would be required.

Unfortunately, politicians often spin these solvency projections as a looming “bankruptcy,” implying a complete meltdown of our social insurance programs. That’s an inaccurate term to apply in the context of a federal program—and solutions to the problems are readily available.

How to Fix Medicare

The 2028 depletion forecast applies only to Medicare Part A, which pays for hospital bills. Unlike other parts of Medicare, Part A is funded through the Medicare payroll tax; Part B (outpatient services) and Part D (prescription drugs) are financed through a combination of general government revenue and premiums paid by beneficiaries. They cannot run out of money, because federal contributions and premiums are set under federal law to cover projected costs.

The political and media focus on the HI trust fund is understandable because of its high visibility and fixed funding source. But it has become less critical over time when viewed as a portion of total Medicare revenue, according to Marilyn Moon, an economist and former trustee of both Social Security and Medicare. In a brief published last year on Medicare’s finances, she noted that with more healthcare services delivered in outpatient settings, the share of total Medicare costs borne by FICA taxes has plunged from 61.8% in 1970 to 36.4% in 2019.

The HI trust fund’s main source of revenue is a FICA tax on payroll of 2.9%, split evenly between employers and employees. The rate was increased several times during the first two decades of the Medicare program (it was signed into law in 1965), but no changes have been made since 1986. (A cap on wages subject to FICA for the HI fund was eliminated in 1994.)

The HI fund has strained to keep up with rising healthcare costs, but the swelling retired population and gains in longevity also strain the program’s financial health. And the coronavirus has had a disproportionate impact on older people, which means that Medicare has been bearing a higher share of the pandemic’s overall healthcare costs.

The 2028 depletion date is not far off. If Congress makes no changes, Medicare will have sufficient revenue to meet 90% of projected benefit costs at that point.

The Biden administration has proposed fixing the problem with several changes to current tax law, as Paul Van de Water of the Center on Budget and Policy Priorities explains:

“As part of its 2022 budget, the Biden administration advanced a proposal that would extend the life of the Medicare HI trust fund for many years. It would close a loophole that allows some pass-through business income of high-income taxpayers to avoid both the Medicare tax on self-employment income and the net investment income tax (NIIT) on unearned income. In addition, the proposal would dedicate both this additional revenue and the existing revenue from the NIIT to the HI trust fund.”

Another option is to increase Medicare payroll tax rates. The Congressional Budget Office has estimated that increasing the total rate by 1 percentage point starting in 2021 would have raised $877.5 billion by 2030.

Congress also could reduce spending in the program—for example, reducing the billions of dollars in overpayments now going to Medicare Advantage programs because of the way they are permitted to charge Medicare for sicker patients in their care. One recent study estimated that Medicare overpaid Advantage plans by more than $106 billion from 2010 through 2019 because of improper risk adjustments.

Legislation to reduce the cost of prescription drugs also could help.

Long COVID and Other Unknowns of Medicare

More generally, the Medicare program faces some unknowns that could affect the financial outlook, Moon noted.

Lingering symptoms caused by COVID-19—generally referred to as long COVID—is one of them. Much remains unknown about the number of people affected and the severity of symptoms, but studies have found that up to 30% of people infected by the virus experience some form of it.

“If long COVID turns out to be something important, that’s potentially a 25- to 30-year issue for older people, including many who are not even on Medicare yet, who will have major healthcare problems,” Moon said. Long-COVID costs could impact both Part A and Part B, depending on whether symptoms are treated on an outpatient or inpatient basis.

Another wild card: expensive biologic drugs that can drive up the cost of care, especially in inpatient and outpatient settings. That was abundantly clear in the unprecedented battle this year over Aduhelm, the controversial Alzheimer’s drug that won approval from the U.S. Food and Drug Administration last year despite objections from the agency’s own scientific advisory panel.

The drug initially was to carry a sky-high price tag of $56,000 per patient annually—a figure that the drug’s maker, Biogen BIIB, miraculously managed to slice to $28,800. What a deal!

Aduhelm is administered in outpatient settings, so the cost would be borne by Medicare Part B, not Part D prescription drug plans. This was a key contributor to the whopping 14.5% increase in the standard Medicare Part B premium for 2022, to $170.10 per month.

Medicare ultimately decided to sharply limit use of Aduhelm but let stand the large Part B hike, citing administrative hurdles to a midyear rebate.

Aduhelm will not be the last instance of a drug-induced price spike.

Social Security Solvency Improves

Most Social Security analysts look at the program’s two trust funds—retirement and disability—on a combined basis. While the combined forecast improved by just one year, the improved outlook for the disability program was notable. A 12.4% FICA tax, split between employers and employees, funds the retirement and disability programs.

The big headline news this year is a revised forecast for the Social Security Disability Insurance, or SSDI, trust fund. The trustees project that it will be solvent and able to meet all its obligations to beneficiaries for at least 75 years. That’s a sharp contrast with earlier forecasts, which often showed SSDI running out of money within a decade.

One reason is that much of the large baby boom generation has moved through the peak years of a likely disability (their 50s and early 60s) and into their retirement phase. Beyond that, the reasons for the improved forecast are less clear. The number of disability awards has fallen sharply during the pandemic. That may be due to the complexity of the disability application process during a time when Social Security field offices were closed, and assistance was more difficult to access. Changes in the labor force and procedures at the Social Security Administration may also play roles.

But the trajectory of SSDI could change yet again. There’s a huge backlog of disability applications awaiting review, and the aforementioned long COVID outlook could also play a role in altering the health of the disability trust fund.

More generally, the looming shortfall weighs on the overall Social Security program. The trustees forecast that—absent action by Congress—the combined funds will be emptied in 2035. At that point, revenue from current tax receipts would be sufficient to cover just 80% of promised benefits.

In other words, everyone on Social Security would face a benefit cut of roughly 20%. The Center for Retirement Researchnotes that the impact on beneficiaries would be disastrous. The percentage of preretirement income that benefits replace would fall from 38% to roughly 27% for the typical 65-year-old worker.

Polling data shows that the public is skeptical—and worried—about the program’s future

Forty-two percent of working Americans tell Pew Research Center pollsters that they doubt they will receive any benefits from Social Security. An equal share thinks they will receive a benefit, but at a reduced level.

Ways to Fix Social Security

Taking action to fix the problem sooner than later would go a long way to restoring public confidence. It would also give future retirees time to adjust to any changes.

In the House of Representatives, legislation has been proposed that would close 52% of the long-term shortfall. It would push the trust fund depletion date back to 2038 by adding new payroll taxes to wages over $400,000—currently, taxation stops at $147,000. Earlier versions of the bill restored solvency for 75 years by also gradually increasing payroll tax rates, but that has been eliminated to reflect President Joe Biden’s campaign pledge not to raise taxes on people with incomes below $400,000 per year.

Sen. Bernie Sanders, the Vermont independent, recently introduced legislation in the Senate that would expand benefits by $2,400 a year and fully fund benefits for the next 75 years by increasing taxes on wealthy households.

If Republicans regain control of Congress, the reform agenda will shift in the direction of benefit cuts. Early versions of Republican reform plans have called for benefit cuts in the form of higher retirement ages and means testing.

Mark Miller is a journalist and author who writes about trends in retirement and aging. He is a columnist for Reuters and also contributes to The New York Times and WealthManagement.com. He publishes a weekly newsletter on news and trends in the field at RetirementRevised. The views expressed in this column do not necessarily reflect the views of Morningstar.

Mark Miller is a journalist and author who writes about trends in retirement and aging. He is a columnist for Reuters and also contributes to The New York Times and WealthManagement.com. He publishes a weekly newsletter on news and trends in the field at RetirementRevised. The views expressed in this column do not necessarily reflect the views of Morningstar.

Mark Miller does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.