The Social Security and Medicare trust funds are both projected to run out of money in about a decade. While it’s possible Congress will tackle these complex funding issues after the upcoming election—perhaps in conjunction with a broader tax bill—resolution is much more likely to be delayed for several years, regardless of which party is in power.
Sharon Carson, Retirement Strategist, explains why this is a topic to discuss now with clients and plan sponsors alike.
Tough challenges ahead
Politicians are divided over how to resolve the looming shortfalls: Some believe the best way to save Social Security is to cut retirees’ benefits; others advocate for higher taxes. A smaller third group recommends taking a middle-ground position: Establish a bipartisan commission to implement a combined benefit-cut/higher-taxes solution.
However, it’s far more likely Congress will continue to put off taking action, fearing a backlash from constituents on both sides of the aisle.
Social Security vs. changing U.S. demographics
The core issue is an aging U.S. population: In 1960, there were 5.1 workers for each Social Security beneficiary. By 2034, that ratio will have dropped to 2.2 workers for each person collecting benefits. (Currently, the worker/beneficiary ratio is 2.8.)
With each passing year, it becomes ever more challenging to shore up the Social Security system without making unpopular decisions—which helps explain why no major reforms have passed into law since 1983, i.e., the last time the trust fund’s depletion was imminent. (A remedy that was not completed until 2023.)
Eventually, though, Congress will be forced to take action—most likely with a solution that avoids angering older voters; which will mean a benefits cut for those near or in retirement is unlikely.
Two possible scenarios:
1. Payroll taxes levied on wages above the current cut-off point ($168,600)
2. Gradual cuts to future benefits for younger, high-earning workers
Medicare vs. escalating health care costs
The future of Medicare is uncertain for similar financial and political reasons. Here’s why.
The Medicare trust fund is made up of two separate trust funds:
- The Hospital Insurance trust fund provides Medicare Part A coverage (inpatient hospital care). This program is financed mainly through payroll taxes on workers’ earnings and income taxes on Social Security benefits.
- The Supplemental Medical Insurance trust fund covers Medicare Part B (physician services and medical supplies) and Part D (prescription drug plan). Financing here comes from general revenues of the U.S. Treasury (income taxes and government debt). The government covers three-quarters of the premium costs for Parts B and D. The balance comes from premiums paid by beneficiaries. (High earners pay surcharges based on their modified adjusted gross income (AGI) plus non-taxable interest.1 )
The funding gap for Part A is dwarfed by government subsidies for Parts B and D. Focusing solely on the solvency of the Medicare trust fund misses the more significant funding challenge.
Plan for the future
Given the dual challenges of an aging population and healthcare inflation, by 2098, Medicare costs under the current regulatory guidelines are projected to climb to 6.2% of GDP—up from 3.8% in 2023. This will increase the burden on taxpayers and/or add to the national debt.
One possible long-term solution: Reduce premium subsidies for beneficiaries who are financially able to pay more. (See chart.)
Thus, regardless of the election results, financial professionals should begin preparing their clients for higher taxes and surcharges down the line. As a first step, clients—with the help of a tax professional—should evaluate the mix of account types in which their assets are held, including traditional and Roth IRAs as well as taxable brokerage accounts.
For their part, employers should consider making Roth accounts a benefit plan option if they haven’t already, and then help employees make informed decisions about which type of retirement account to choose.