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Medicare Is in Even Worse Shape Than We Thought

By Matthew Frankel, CFP® - Jun 10, 2018 at 6:47AM

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It looks like Medicare is running out of money faster than previous estimates had called for.

Medicare, the nation's largest health plan covering virtually all of America's senior citizens, ran a $2.8 billion surplus in its hospital insurance trust fund in 2017. Good news, right?

Well, yes and no. A Medicare surplus is certainly not a bad thing to have, but the 2017 surplus is expected to be the last one for the foreseeable future, according to the recently released 2018 Medicare trustees' report. In fact, while we already knew that Medicare was on the path toward running out of money unless reforms are enacted, it now looks like this will happen significantly sooner than we thought.

Pills spread out on top of money.

Image Source: Getty Images.

Medicare's reserves could run out three years sooner than previously expected

In the 2017 Medicare Trustees Report, the hospital insurance (HI) trust fund that funds Medicare Part A was forecast to be depleted in 2029. Now, the recently released 2018 edition of the report found that the estimated depletion data for the trust fund is now 2026 -- three years earlier than previously expected and just eight years from now.

In fact, the $202 billion in assets held in the HI trust fund at the end of 2017 represents just 68% of 2017 expenditures. For comparison, the Social Security trust fund -- which is projected to run out in 2034 -- holds reserves equal to about 290% of its annual expenditures.

It's important to mention that when you hear about Medicare's funding crisis, it's generally referring to the HI trust fund. This is the fund that pays for Medicare Part A, hospital insurance, and derives the majority of its income from payroll taxes. On the other hand, the Supplementary Medical Insurance (SMI) trust fund, which covers Medicare Parts B and D, isn't as much of a concern, as it's funded primarily by the premiums paid by beneficiaries, as well as general revenue income, which can be easily adjusted to accommodate rising costs.

Why will Medicare run deficits going forward?

Obviously, the details behind why Medicare is expected to run out of money are far too extensive to thoroughly discuss here. That's why the Medicare Trustees' Report is 260 pages long.

However, the reasons Medicare is in trouble can be simplified into two main points. First, Americans are living longer lives, in general, so the average beneficiary is drawing benefits for a greater number of years than in previous generations. And second, the massive baby-boomer generation will be gradually reaching retirement age over the next two decades or so.

The effect is that there are going to be far fewer workers paying into Medicare in the future relative to the number of beneficiaries.

Why did the projection change?

The reason for the change is lower-than-expected hospital insurance income combined with higher-than-expected spending by the program.

Specifically, HI income is projected to be lower due to lower payroll taxes, lower projected GDP (gross domestic product) growth, and lower income from taxable Social Security benefits. On the expenditures side, the trustees' report cited "legislation that increased hospital spending, and higher Medicare Advantage payments."

What does this mean for you and how could we fix it?

In a nutshell, this means that Medicare's funding gap will need to be fixed before 2026 or benefit cuts will be necessary. The good news is that there's still time to fix the problem, and history tells us that something will be done. There are some dramatic changes, such as privatizing Medicare or switching to a single-payer healthcare system, but if the goal is to maintain Medicare in its current form, the only two solutions are to increase the program's income or decrease expenditures.

The trustees' report found that the 75-year actuarial deficit for Medicare is 0.82% of taxable payroll, so a tax increase of that magnitude could solve the problem all by itself. The current Medicare payroll tax rate is 2.9% (1.45% each for employees and employers), so this would translate to a new rate of 3.72% (1.86% each).

On the expenditure side of things, one potential solution would be to increase the Medicare eligibility age. This would make sense -- after all, Americans are living generally longer lives and the Social Security full retirement age has been raised to 67 for those born after 1960. So it wouldn't be out of the question to increase the Medicare eligibility age to match it.

These are just two of the potential solutions, and there certainly are others. However, one important point is that any solution will be easier to implement the sooner we act. As the trustees' report puts it, "The sooner solutions are enacted, the more flexible and gradual they can be."

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