The Pandemic, Social Security, and Medicare

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Christine Benz: Hi, I'm Christine Benz for Morningstar. The current pandemic and its related economic crisis have sparked concerns about the future of Social Security and Medicare. Joining me to discuss that topic is Morningstar contributor and author Mark Miller. Mark, thank you so much for being here.

Mark Miller: Thanks, Christine.

Benz: Mark, let's discuss the relationship between this current economic downturn and Social Security. What are perceived to be sort of the biggest threats potentially to the financial health of Social Security?

Miller: Well, I guess I'd like to say, before I even answer that question, that this is not at the top of my list of worries about retirement security right now. There are some concerns that we'll get to. But really a much bigger worry to me right now is the whole retirement saving system. The market dropped back February and March according to the Center on Retirement Research. Took about $4.4 trillion out of DC plans and IRA plans, IRA accounts. It's a kind of a breathtaking figure. Now, a lot of that has probably come back as the market has rebounded, but you got to think a lot of damage was done there for anybody who made bad decisions during that period.

If you look at the CARES Act and the possibility of widespread withdrawals under the very liberal withdrawal rules of that law, I think there's a good chance a lot of people are going to be draining their accounts. Employer matches have been suspended on a pretty wide basis. I'm really worried about widespread 401(k) plan terminations among small employers. If we see a big wave of bankruptcies and liquidations of companies, small firms primarily, we're going to see a lot of small 401(k) plans terminated. So, by comparison, I would say Social Security and Medicare are absolute rocks of stability.

Benz: Good point. Apart from those real concerns about people's retirement savings, there are some knock-on effects when we do encounter this sort of downturn, some implications potentially for Medicare and Social Security. I would think just big unemployment numbers and declining tax receipts would potentially have implications.

Miller: Right. So for Social Security, the actuaries of Social Security are saying that the downturn in payroll tax collections could move forward the date when Social Security's trust fund becomes exhausted by a year or two. There are some other forecasts that are a little more aggressive. That the depletion date could move up even further than from 2035 down to ... the actuaries are saying 2033. Could it be sooner? Much will depend on how long and deep the downturn is. But with a program this large, it's just a gigantic system. Think of it as sort of in the classic analogy of the battleship: It's slow to turn, slow to stop. It's not something that is going to be affected overnight in a dramatic way to the tune of $4.4 trillion coming out of DC plans and the like. So yes, there are reasons to be concerned, but I think still it's a manageable situation.

Benz: How would you address concerns from pre-retirees who might say, "Well, maybe, should I speed up my filing from Social Security if I'd rather get my benefits started and lock them in?" What do you think about people doing that kind of strategizing because they're worried about Social Security?

Miller: I don't think it's a way to think about it. I would think about it more from the personal financial standpoint of what's right for you in terms of what income needs you're going to have, how long you will be able to work, what kind of savings you have available. What's more, there's no such thing as locking it in. The reality of the 2035 exhaustion date is that, if we get to that, and I don't believe we will, that would imply a cut in benefits across the board of 20% for--including people receiving benefits. Just filing doesn't protect you from a cut down the road. So it's not an available strategy. There is no protection from that. That actually is why I think it's not going to happen. I cannot possibly imagine Congress allowing a 20% cut in everybody's Social Security benefits. It's just, to me, unimaginable that that's going to be permitted from a political standpoint.

Benz: I think some younger investors and financial advisors who work with them might automatically incorporate some type of reduction in their Social Security benefits, especially those who are higher net worth, higher income types. How should younger investors think about that in terms of how much of a Social Security benefit to expect?

Miller: Right. If you want to think about that question from a conservative planning standpoint, a lot of planners like to build their plans out for clients assuming they'll all live to age 100. Well, that's a very conservative way to plan. They won't all make it to 100, unfortunately. And if you want to go with a conservative assumption that Social Security is going to get cut 20% in 2035, go for it, but it's going to make your plan a lot more challenging. It's quite an eye opener when you give Social Security that kind of a haircut. So, if you want to plan with that conservative assumption, great. The worst thing that'll happen is you will be that much ahead when it doesn't happen.

Benz: We've largely talked about Social Security here so far, but Medicare-related program: Let's talk about the health, the financial health, of Medicare and whether you think there are implications from the pandemic for Medicare.

Miller: This is interesting because Medicare's funding is more complicated than Social Security. Social Security is funded mostly from the payroll tax. It also receives some income from interest on bonds and the trust fund and from taxes on Social Security benefits, but it's primarily the payroll tax. Medicare, because it has several parts, the parts are funded differently. The large source of funding is general federal revenue, about 43%, payroll taxes are about 36%, and beneficiary premiums, about 15%. It breaks out differently by parts of the program.

So, if we take it in pieces: First you have Part A, which is the hospitalization feature. That is financed mainly through a 2.9% payroll tax that's split by employers and employees. Similar to the Social Security tax, it's just collected from paychecks. Part B, which is outpatient services, is funded through general government revenue, about 70%, and the rest from beneficiary premiums. Part D, prescription drugs, is similar to Part B. It's a mix of general revenue and beneficiary premiums. So you can't just say, "Well, Medicare's finances will be affected this way across the board." It's important to break it down and look at the different parts. In short, I would just say that Part A, Hospital Insurance Trust Fund, is a key area of concern right now. We could talk a little bit more about that if you would like.

Benz: Well, let's talk about that trust fund. What are the possible actions? It sounds like Congress will have to take action on that.

Miller: Yeah. The Hospital Insurance Trust Fund is kind of volatile. The forecast for its financial health often bounces around quite a lot. Not from year to year, but over time you can see this on charts. Before the pandemic, the fund was forecast to be exhausted in 2026, so not all that far from now. At that point, Medicare would have enough money coming in from payroll taxes to meet about 90% of its cost, so something would need to be done there. We're likely to see a revised forecast when the Medicare trustees issue their next report on the program next spring. Like I say, it's going to be something Congress is going to need to address. It's a little uncertain how exactly this will play out. But most of the experts I talked to do expect that exhaustion date might move up by a year or two. So, of all the things we're talking about, this might be the most immediate problem that needs to be addressed by Congress.

Benz: How about Medicare premiums? Do you expect to see those move up further still?

Miller: Well, Medicare premiums, Part B premiums, were already jumping pretty sharply before the pandemic. Part B premium has risen 38% since 2015. The trustees were predicting more escalation in those rates before the pandemic. I think it's reasonable to think we'll see some bigger-than-general-inflation increases in the Part B premium in the years ahead.

Benz: Mark, important discussion. It's always great to get your perspective. Thank you so much for being here.

Miller: Thanks for inviting me, Christine.

Benz: Thanks for watching. I'm Christine Benz for Morningstar.