A ‘grand bargain’ doesn’t add up

MarketWatchMy latest “Retirementor” column is now available at MarketWatch.  Here’s a taste:

“The conclusion is unmistakable: Americans wants a generous welfare state without having to pay for it . Continue reading

The Numbers Don’t Lie

My latest column at Research magazine is now available.  Here’s an excerpt:

Those approaching retirement are justly terrified about health care costs and the stability of Social Security. Many also fear that “reform” will effectively kill Social Security and Medicare. But the reality is that they will necessarily die on their own without some significant changes. Our retirement planning efforts are not going to mean much unless we address the ongoing issues we have with Social Security and (especially) with Medicare. The numbers don’t lie.

The Numbers Don’t Lie

The Numbers Don’t Lie

The 2012 Retirement & Politics Survey by Allianz Life Insurance Company of North America has found that those the survey defines as “Transition Boomers” — people between the ages of 55 and 65 who are less than 10 years away from retirement — see rising health care costs and Social Security as having the greatest impact on their retirement outlook.  According to the survey, 67 percent of all Transition Boomers listed health care expenses as their top concern. Social Security ranked second at 53 percent.  The survey was conducted this past September 17-20 among a random sample more than 1,200 Baby Boomers.  

These fears are not without merit.  Social Security and Medicare, which provide retirement income and health insurance coverage to American seniors, account for nearly half of all federal spending. We Boomers (all of us, not just the Transition Boomers) are more than 75 million strong and the first of us turned the traditional retirement age of 65 just last year.  Because there are so many of us, the ranks of the retired will continue to grow while the ranks of those supporting us – via paying for entitlements such as Medicare and Social Security – will continue to shrink.  We’re living longer too.   In 1950, the average American lived for 68 years and more than 16 workers supported each retiree. Today, the average life expectancy is 78 and fewer than three workers support each retiree. Health care costs continue to explode higher as well.

For the vast majority of us, our retirement planning will mean little without the foundation provided by Social Security and Medicare.  For low-income people, Social Security replaces up to 90 percent of covered wages. For higher income workers, those who earned the maximum Social Security wage for 35 years or so, the rate is only about 28 percent.  Even so, unless Social Security and Medicare are shored up in a comprehensive and fiscally responsible manner, whatever else we Boomers do to plan for retirement will be much less significant, if not irrelevant.

Each year the Trustees of the Social Security and Medicare trust funds report on the current and projected financial status of the two programs. The most recent annual report yet again says that the finances of Medicare and Social Security are in serious trouble.  The Congressional Budget Office projects that if Medicare retains its current structure, it will be bankrupt by 2022. Social Security’s chief actuary calculates that a 23% cut in benefits in 2036 will be required in order to maintain solvency of the Social Security Trust Fund.

Unfortunately, as the current election season demonstrates, there is little demand for Social Security and Medicare reform and little political will to move this issue forward.  Not surprisingly, we want more and better benefits but we don’t want to have to pay for them. That said, a number of reform proposals have been put forward.

Proposed Social Security reforms range from relatively simple and limited adjustments (such as changing the benefit formula, tax rate and/or full retirement age) to more aggressive approaches (including means testing or even a diversion of workers’ payroll taxes into individually owned and dedicated private retirement investment accounts).  Despite this wide range of Social Security reform proposals, the program can be shored up reasonably well with relatively modest changes.  Change has to happen but no major overhaul is required.

Medicare, on the other hand, is much worse off and requires a much more aggressive response. The $38.6 trillion in unfunded benefits Medicare is expected to pay over the next 75 years equals $328,404.43 for each of the 117,538,000 households the Census Bureau says were living in the United States in 2010.  The Medicare problem is a big one.

As Forbes has reported, the American Medical Association’s key policy committee, the Council on Medical Service, recently voted to endorse a Medicare reform plan that shares key traits with those proposed by the Romney campaign. Ironically, despite these similarities, the AMA Council’s report states that it came to this view based upon the advice of Bill Clinton’s former budget chief, Alice Rivlin.  Proposed Medicare reforms offered by others include (a) adjusting the Medicare eligibility age to reflect gains in life expectancy; (b) capping out-of-pocket costs to protect recipients from bankruptcy in the event of a major illness; and (c) requiring wealthier beneficiaries to pay higher premiums. 

Despite the political unpopularity of being seen as cutting benefits to seniors, serious changes are needed.  But getting reform implemented is likely to be politically difficult because there is so little perceived “upside.”  No matter how necessary, “reforms” that result is lower benefits or more limited accessibility to benefits are not politically popular. Historically, Social Security reform has been the “third rail” of American politics.  Medicare is highly popular as well.

Predictably, therefore, representatives of the primary political factions continue to blame each other for the overall problem but do nothing.  It’s easy to blame Congress (with good reason), but we as a nation do not demand more and better from them either.

If we continue to do nothing, things will only get worse.  Right now, the ratio of those 65 and older versus those 15-64 is right around 20%. By 2035, it’ll be closer to 35%, meaning that many fewer workers will be supporting many more retirees. 

 In 1962, about 32 cents of every federal dollar, excluding interest payments, was spent on public “investments” such as defense, infrastructure, long-term research and education.  On the other hand, only 14 percent of every federal dollar was spent on entitlements like Medicare and Social Security. Today we spend less than 15 cents on such public investment but a whopping 46 cents on entitlements. By 2030, when all the Baby Boomers have started collecting Social Security, entitlements will consume fully 61 cents of every federal dollar.  Whatever political priorities one might choose as appropriate investments in our children’s future in this election season, without entitlement reform we will not be able to afford them.

Since the inception of Social Security and Medicare, these programs have provided benefits to all who have worked in covered employment for a sufficient period and to their dependents and beneficiaries, without regard to wealth or other income. This universality reinforces the idea of Social Security and Medicare as an earned right, and is crucial to the programs’ ongoing popular support. These related concepts – earned right and universality – distinguish Social Security and Medicare from other government income-maintenance programs, such as welfare, food stamps and Medicaid, which provide benefits only to those who are deemed to need them.  Not surprisingly, these latter programs have all been subject to major overhauls or benefit cutbacks in recent years.

Those approaching retirement are justly terrified about healthcare costs and the stability of Social Security.  Many also fear that “reform” will effectively kill Social Security and Medicare.  But the reality is that they will necessarily die on their own without some significant changes.  Our retirement planning efforts are not going to mean much unless we address the ongoing issues we have with Social Security and (especially) with Medicare. The numbers don’t lie.

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Entitlement Trouble

Each year the Trustees of the Social Security and Medicare trust funds report on the current and projected financial status of the two programs. This year’s annual report (summary here) says that the finances of Social Security have worsened in the past year.  The lifespan of the Social Security trust fund has been shortened by three years such that (without adjustments) Social Security benefits will now run out in 2033.  This worsening is the result of high energy prices and a slow economy, the Trustees said yesterday.

While this isn’t good news, obviously, it is consistent with the ongoing theme that Social Security is not in crisis, but does need some tweaking. On the other hand, per the Trustees, Medicare is in greater trouble, although it hasn’t gotten a lot worse lately.  The Medicare fund for seniors’ health care is scheduled to run dry in 2024, which is unchanged from last year, largely because of a 2 percentage point cut enacted by Congress last year. Moreover, as reported by the Trustees, “Medicare’s actual future costs are highly uncertain and are likely to exceed those shown” by existing data.

As summarized by the Trustees:

Social Security and Medicare are the two largest federal programs, accounting for 36 percent of federal expenditures in fiscal year 2011. Both programs will experience cost growth substantially in excess of GDP growth in the coming decades due to aging of the population and, in the case of Medicare, growth in expenditures per beneficiary exceeding growth in per capita GDP. Through the mid-2030s, population aging caused by the large baby-boom generation entering retirement and lower-birth-rate generations entering employment will be the largest single factor causing costs to grow more rapidly than GDP. Thereafter, the primary factors will be population aging caused by increasing longevity and health care cost growth somewhat more rapid than GDP growth.

The best response should be obvious. “Lawmakers should not delay addressing the long-run financial challenges facing Social Security and Medicare,” the Trustees wrote in their report, and added that “If they take action sooner rather than later, more options and more time will be available to phase in changes so that the public has adequate time to prepare.” Sadly, such a response is unlikely amidst the disfunctionality that engulfs Washington.

Predictably, representatives of the primary political factions issued statements blaming each other.

“The biggest threat to Medicare and Social Security is doing nothing, and the refusal of the White House and congressional Democrats to address our fiscal challenges will have devastating consequences for America’s seniors,” said House Speaker John Boehner (R-Ohio).

House Minority Whip Steny Hoyer (D-Md.) said the Obama health care plan will help save money in Medicare, while Republican budget plans threaten both it and Social Security.

“While Republicans would repeal the Affordable Care Act and are doubling-down on a budget that ends the Medicare guarantee, Democrats will continue to stand up for Social Security and Medicare,” Hoyer said.

The proposals on Social Security reform contained in the December 2010 report of the co-chairs (their was no official report, contrary to consensus opinion) of President Obama’s deficit reduction panel (the Bowles-Simpson commission) include closing about half the gap by gradually increasing the amount of wages subject to tax. Accordingly, the Social Security tax would be imposed on the first $190,000 of wages in 2020, versus about $168,000 under current law.  This year, the tax is imposed on the fist $110,100 of income from wages or self-employment.

The rest of the shortfall would be made up with a gradual increase in the “full” or “normal” retirement age” for Social Security, less generous benefits for the relatively highly paid, and reducing the annual cost of living increase for the already retired by about 0.3 percentage points a year, with an upward adjustment after a beneficiary had been on Social Security for 20 years to soften the cumulative effects. The retirement age increases would start with those born after 1960 (that’s where already legislated retirement age increases end). The 1983 Social Security fix raised  the full retirement age for those born from 1943 through 1954 to 66, boosting it another two months per year after that to 67 for those born in 1960 or later.

Those with more money already get back less relative to what they have paid in than low-income workers; the Simpson-Bowles recommendations would increase that disparity.  Combined with a higher retirement age, the National Academy of Social Insurance has calculated that the Simpson-Bowles proposals would lead to 30% lower benefits for a high earner born in 1975 than one born in 1945.

Is There a Retirement Crisis?

The current (Autumn 2011) City Journal tackles the retirement crisis in a compelling article by Nicole Gelinas.  It begins by reciting what are now well-known retirement problems for the baby boom generation — lost wealth due to the financial crisis, the spectre of reduced Social Security and Medicare benefits, more seniors with fewer workers to support them, stagnant earings for more than two decades, and excessive debt. 

Not surprisingly, those approaching retirement are working longer in general and are very nervous about their prospects. The most recent Census data shows that among men 65 and older, 22 percent are in the labor force, up from 16 percent just a decade earlier. Fewer pensions create issues as well.  In 1980, when the baby boomers were young, 60 percent of private-sector workers with retirement plans could rely on guaranteed employer pensions. That figure is 7 percent today (although public employees still tend to have pensions). 

But there’s ultimately no way around it: baby boomers will eventually have to retire (if only due to health), and to do that, they’ll need more savings than they’ve managed to accumulate so far.

That said, Social Security isn’t in nearly the mess that so many assume.  It needs work, surely, but the problems are manageable.  Even without changes, Social Security’s trust fund should last until 2037 under current law.  But for workers with at least middle class incomes, much more than Social Security will be needed to replace their working life incomes. 

Unfortunately, Americans currently save only about 5 percent of their incomes — up from the near-zero levels of half a decade ago but still nowhere near the 10-15 percent savings rate most experts recommend (see Wade Pfau’s excellent discussion of safe savings rates here). We need a dramatic shift from spending and borrowing to saving and investing to have a reasonable chance at success overall. 

Gelinas recommends a major increase in deductible IRA contribution limits and also advocates the elimination of capital-gains, dividends, and interest taxes on anyone earning less than $250,000 a year, since these taxes discourage people from investing.  But saving more is only a partial solution.  Workers need better returns too. Indeed, average returns in the 8 percent range (as opposed to the 5 percent range) would go a long ways toward solving the younger boomers’ problems.
 
Of course, the biggest retirement uncertainty remains health care.  If health care costs are factored in, the typical rule of thumb that one should replace 80 percent of working income in retirement might need to be replaced by a figure in excess of 100 percent (which isn’t plausible practically).  The problem isn’t so much the costs that Medicare covers (although Medicare is in deeper trouble than Social Security), it’s the long-term care costs that Medicaid covers — since Medicaid requires that its recipients be demonstrably poor to benefit.  However, few people tend to buy long-term care insurance and the prospect of expanding Medicaid coverage is a political non-starter today.
 
According to Gelinas, the “most disturbing statistic on older-worker employment is this: in 2010, only 77.6 percent of men 55 to 59 years old were working or looking for work….”  Moreover, “[i]n 2009, only 14 percent of new male Social Security beneficiaries were of ‘full retirement age’—a precipitous fall from the 26 percent figure of the previous year. It was the lowest rate ever. Unless older unemployed people get back to work soon, they’ll never go back, and they’ll become poorer retirees than they needed to be.”   
 
Gelinas concludes with the obvious:  “fixing our economy now is the most important task of all.”  She suggests that we “let the housing market find its bottom, so that people who want to cut losses on bad housing debt have the information they need to make such a momentous decision. Invest massively in infrastructure. Fix the tax code to channel money out of debt and into innovation. Fix immigration so that we continue to attract the world’s smartest people. These measures would get people back to work soon and prepare the nation better for the future, making it likelier that those who will shoulder the burden of caring for an aging population are able to do it.” 
 
It’s pretty good advice.