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How Safe Is Your Medicare?

By Dan Caplinger – Jul 17, 2016 at 7:23AM

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Talk about the Medicare program's financial condition sounds dire, but it addresses only part of the issue.

Image source: Getty Images.

Tens of millions of Americans rely on Medicare to help them with healthcare expenses, and concerns about the program's financial viability have many retirees and near-retirees worried about whether they'll continue to get the coverage they need. In particular, the recent report from the Trustees of the Medicare Trust Fund claims that the fund will be depleted by 2028. That raises the question of what happens after then. But unlike Social Security, Medicare has traditionally drawn on the overall federal budget. Therefore, as long as Congress and the president agree to fund Medicare, benefits should remain available. Below, we'll take a closer look at how Medicare funding really works.

Medicare's trust fund

The most obvious sign of financial stress on the Medicare program comes from the Medicare trust fund. Technically, the trust fund is composed of two parts, one that covers hospital insurance and the other that covers supplemental medical costs. The part for hospital insurance, dubbed the HI fund, gets its funding from the payroll taxes that most workers pay from their earnings. Employees have 1.45% withheld from their pay, and employers are responsible for a matching 1.45% tax payment as well.

The HI trust fund will run out of money in 2028, according to the most recent figures from its Trustees. In 2015, the trust fund had to redeem $3.5 billion in assets in order to cover the shortfall from tax revenue and interest paid on the trust fund balance, bringing the balance down to $193.8 billion. Although the trustees expect slight surpluses in the program from 2016 to 2020, deficits thereafter will begin to reduce the amount of money left in the HI fund over the following eight years.

The rest of the story of Medicare's finances

By contrast, the supplemental medical insurance part of the Medicare trust fund, dubbed the SMI fund, has operated with minimal reserves for a long time. The reason is simple: rather than getting its funding from dedicated sources like payroll taxes, the primary funding source for the expenditures Medicare makes on supplemental medical services is the federal government. The premiums that participants pay for Part B medical coverage and Part D prescription drug coverage cover a portion of the costs of those two parts of Medicare, but the two programs cost the federal government $272 billion in expenditures from general revenue in 2015. The roughly $69.5 billion held in the SMI fund is just a small fraction of its annual outlay, showing how essential ongoing funding from the federal budget is for Medicare.

The most important variable for the financial viability of Medicare as a whole is how quickly the costs of healthcare rise. The most recent Medicare Trustees' report includes several assumptions about the pace of growth in expenditures, including an assumed 3.8% rise in total Medicare outlays per beneficiary. Prescription drug costs are projected to rise at a faster 4.5% rate, while hospital and medical coverage costs are likely to remain in the 3.6% to 3.7% range.

If those cost estimates prove to be too optimistic, then a faster pace of cost growth could endanger Medicare more quickly. In turn, that could spur lawmakers to consider reforms sooner than they otherwise would. On the other hand, if actual future costs rise at a slower pace than currently feared, then it could buy Medicare more time to structure reforms.

The future of Medicare

The most important takeaway about the safety of your Medicare benefits is that the hot-button issue of the depletion of the HI fund is only part of the story. For that part, an increase in payroll taxes to 1.82% on employees and employers alike would close any funding gap. Yet any added financial needs for the medical portion of Medicare will require further spending from the federal budget, and that could prove to be increasingly burdensome as time goes on.

Medicare is an essential program for retirees, and understanding the ins and outs of its financing is important in judging its safety. Retirees can rely on Medicare continuing to exist for the foreseeable future, but fundamental reforms might be necessary in order to make the program better-funded in the years and decades to come.

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