Monday, July 21, 2014

Social Security and Medicare

There are times we read things that cause us to say, as my friend puts it, “I’ll have to think on that.”  Such a time occurred as I read an article in the April 28, 2014 Investment News (pg. 40) written by Mary Beth Franklin. The basic premise was that, in some cases, Medicare costs could exceed the Social Security benefit that one receives. Let’s look at that possibility.

Social Security and Medicare-2014

For 2014, the Social Security tax rate is 6.20% of the first $117,000 of earned income (a maximum tax of $7,254). The Medicare tax rate is 1.45% of all income earned (no upper income exclusion). Thus, most employees pay 7.65% of the first $117,000 earned in Social Security (OASDI) and Medicare (HI) taxes. That is the employee portion only; employers pay an equivalent amount. Self- employed individuals pay a tax rate of 15.30%. As of Jan 1, there is an additional 0.9% Medicare tax (added by Obamacare legislation) on individuals earning greater than $200,000 and couples earning greater than $250,000.  Thus, the maximum tax rate could be 8.55% (6.20% + 1.45% + 0.9%).

Now consider Medicare costs. Medicare Part B (medical insurance) is deducted from an individual’s Social Security benefit every month. There are two components: one for medical expenses and one for prescription drug services. Since the prescription drug service costs vary by location/plan, we will discuss only the medical insurance costs. As one’s income level increases, so does the cost of medical insurance (i.e. an increase in the amount deducted from monthly Social Security benefits). That scale (for 2014) is shown below:

Modified Adjusted Gross Income (MAGI)            Part B Premium                Drug Plan

Indiv <$85k; Couple<$170K                                  $104.90/month                 Per plan

Indiv $85k-$107k; Couple $170-$214k                  $146.90                            Plan + $12.10

Indiv-$107k-$160k; Couple-$214k-$320k             $209.80                            Plan + $31.10

Indiv-$160k-$214k; Couple-$320k-$428k             $272.70                            Plan + $50.20

Indiv->$214k; Couple->$428k                               $335.70                            Plan + $69.30
The maximum Social Security benefit in 2014 is $2,642 at full retirement age. The cost of living allowance adjustment (COLA increase) for 2014 was 1.5%. Therefore, a high income individual might be receiving at most $2,236.90 ($2,642-($335.70+$69.30)) less his/her individual prescription plan costs. (Note: These figures were taken from the Social Security website and are applicable for 2014; they change each year).

What’s to Come?

One needs to spend only a short amount of time watching news/economic television channels to see numerous discussions that “something must be done” about entitlement programs (Social Security/Medicare). The current trajectory is unsustainable. Various solutions have been proposed: 1) Increase taxes, 2) Raise the retirement age for Social Security benefits, 3)Means test benefits (those individuals with higher incomes will receive lower/no benefits from Social Security), or some combination thereof. The purpose of this blog is not to suggest solutions for the problem; that is in the political arena and, given current political conditions, who knows what will happen. Our purpose is to suggest that plans must be made for significant changes in health care expenses as one prepares for retirement.

Health care costs are expected to increase by 5-7% per year and Social Security benefits to increase by 2% (unless changes are made to the COLA adjustment index- such as use of a “chained CPI” calculation-but that is another discussion entirely). Bottom line—health care expenses will consume a greater proportion of Social Security benefits (if any are received) in the future.

In previous a previous blog found HERE we have discussed costs of health care under the current Medicare plans. They are significant—providing approximately $300-400,000 for a couple in excess of existing Medicare benefits. Any changes made in the current plan will only exacerbate the shortage of money needed for health care in retirement.

What to Do?

Prudent financial planning requires that one take appropriate action to prepare for contingencies that appear possible or probable. If one looks down, sees a steel rail on the left, a steel rail on the right, and a bright light down the tracks in the distance, a good course of action might be to step off the railroad track. So what does one do? Work longer? Save more? Spend less? Move to a lower cost of living state? Purchase long term care insurance?

We at Paragon Financial Advisors do not sell any commercial products (insurance, etc.).  We help our clients evaluate personal circumstances and assist in determining the best course of action.  Paragon Financial Advisors is a fee-only registered investment advisory company located in College Station, Texas. We offer financial planning and investment management.
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