Post #6 – What can you expect from Social Security and Medicare? Part II
I have done a lot of reading and talked to many professional financial planners about what changes may be coming to federal old age entitlement programs as well as private pensions and state government retirement programs. I will provide the general thinking by experts on what may lay ahead for the old age entitlements and how you should allow for them in your retirement planning. These views are not my own but a summary of the perspective of several financial planning and policy experts with no agenda other than trying to predict the changes to these entitlement programs and how they might impact peoples’ retirements.
Corporate Pensions – First the Good News
If you are receiving or are about to receive a corporate pension, your benefits are unlikely to be changed. By law private company pension funds must be actuarially sound. That is, private corporation pension funds must have real assets backing their pension obligations. There is some possibility for a corporate pension plan to be underfunded, but there are laws that regulate this and they require that any underfunded plans be made whole within a certain period of time. More importantly, the overarching thinking among experts is, by 2011, any corporation that is going to make a major change to their pension plan has likely already done so. Even so, some experts advise individuals, if you are more than 5 years from retirement, that it may be prudent to assume in your planning that your pension benefit will be frozen at the current benefit (i.e., frozen at the benefit you would receive if you left the company today). The current benefit, based on your time and years to date with a company, is the only thing that is guaranteed. As the years move on, you can revisit your pension benefit and update the benefit in your retirement planning as appropriate.
The one thing you should keep in mind is corporate pensions are usually fixed pensions, i.e., payouts are not adjusted for inflation. Therefore, to allow for inflation in your retirement planning, you should reduce your payout amount. As such many experts advise, when planning retirement income, you should reduce your fixed pension amount by as much as 33% to 50%. The lower figure would apply to people retiring relatively late (after age 70), and the 50% figure would apply to people retiring at a relatively young age (before age 60). The experts also recommend, if you are slated to receive some kind of subsidized corporate health care benefit, to assume the subsidized health care benefit will be discontinued. Unless you are governed by a labor union agreement, health care benefits are not guaranteed, even after you retire.
State Government Pensions – Not Such Good News
Unfortunately, for state government provided benefits the situation is a little more uncertain. State government pension and health care plans are generally not actuarially sound. Most states have rules that govern the actuarial requirements of their pension funds, but these rules are much more lax than the laws governing private pensions and politicians are constantly playing budgetary games with them. The bottom line is most state’s pension funds are underfunded. Unless you are already retired or very near retirement, there is a high likelihood that changes are coming to your pension plan. In fact 20 states have enacted changes just in 2010 alone. You can view these changes on this link. As with a corporate pension some experts recommend that, if you are more than 5 years from retirement, you should assume that your pension benefit will be frozen at the current payout (updating this payout benefit in future years as appropriate if the pension plan has not been frozen), until you are retired. Currently virtually all state pensions are regularly adjusted for inflation. Experts recommend that your planning assume the inflation adjustments will cease or be dramatically reduced in the future. Furthermore, if your state retirement plan includes a separate health care benefit or a medicare gap plan, the information I have read seem to suggest it is best to assume that any state health care subsidy will end when you become eligible for medicare.
Federal Government Entitlements – The Really Bad News
Unless you are at or near the poverty level when you retire, you are not going to receive the social security benefit that is included in your annual statement (unless you are just a few years away from retirement). If you have not received this annual statement, you can get a copy of it at this site. I know many people do not want to hear that after decades of paying taxes, they will not receive the benefits that have been promised. What about the social security trust fund you ask? Well, unfortunately, those funds have been spent on other government programs. The social security trust fund only holds large IOUs, i.e., government bonds, in place of these funds. This article on the Daily Reckoning web site explains the situation in more detail. The cold hard reality is: Those of you who have saved diligently for retirement are going to be made to pay for those who have not. This will happen through some kind of government confiscation of your wealth. I will discuss in future blogs ways to reduce this impact.
Having said all that, you will receive a social security benefit. There are many ideas being tossed around among federal policy experts about how to “fix” the social security problem. There is talk about, for future benefit recipients, increasing the retirement age, “means-testing” benefits,” or a combination. Several financial planners I spoke to say, if you are at or near retirement, your social security benefit is unlikely to be reduced down the road unless you are a high income retiree. However, if you are currently less than 55 years old, your benefit is likely to be reduced from the outset through some kind of formula or age requirement change. The younger and higher income you are, the greater your benefit will be reduced. There may not be the political will to make these changes today, but, at some point, the changes will have to happen. For retirement income planning it is best to assume a reduced social security benefit and that the inflation adjustment will be less generous in the future. In my personal planning, to allow for future benefit cuts and inflation, I am assuming a 50% reduction (based on the current benefit formula) in my annual benefit from the first day I start collecting payments.
The medicare program is actually in worse financial shape than social security, however nowhere have I read that this program will be significantly changed in the near future, not even raising the age for eligibility currently set at 65. This can only mean that the medicare program will slowly grow to be a much larger share of the total federal budget squeezing out other programs. This does not seem sustainable to me, but I guess this represents the sacred cow status of the medicare program. In any event, policy experts certainly believe that the medicare program will continue the recent trend of raising the Part A and Part D deductibles and the premiums for Part B for everyone and that wealthier beneficiaries will be subjected to even greater means-testing for these out-of-pocket costs. This means that you will need to plan for spending more of your retirement dollars on health care than current retirees do. This analysis completed by Fidelity Investments came to the conclusion that, in 2010, a 65 year old retired couple will, on average, need $250,000 as part of their retirement nest egg to pay for out-of-pocket health care costs for the rest of their lives. This is only one viewpoint, but it gives you some idea of the magnitude of the funds required. I am not currently eligible for medicare and I pay for my own private health insurance which costs about $12,000 annually (including deductibles and co-pays) for both me and my wife. My retirement plan assumes that I will still be paying this same inflation adjusted amount annually for out-of-pocket costs even after we are both eligible for medicare.
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