Healthcare is one of the most unpredictable expenses you'll face after you retire, and Medicare coverage is the primary way that tens of millions of Americans protect themselves from the potential financial catastrophe that an unanticipated illness or injury would otherwise cause. Yet, as important as Medicare is for your long-term financial security in retirement, many retirees don't appreciate just how great a deal the program is until they see one shockingly large number: the difference between how much they've paid in Medicare taxes over the course of their lifetimes and how much they're likely to save on medical costs as a result of having Medicare coverage for the rest of their lives.
Later in this article, you'll learn just how big a number that can be for people in different family situations. First, though, let's take a look at how Medicare taxes work, and why so many Medicare recipients get so much for so little.
Who's this FICA guy?
Most people notice the taxes that get taken out of their paychecks. Apart from income taxes, the biggest amount that gets taken out of your check goes toward Federal Insurance Contributions Act taxes, better known on most paychecks as FICA. FICA actually combines both Social Security and Medicare taxes into one line, but the amounts that go to each program are far from equal.
Of the $7.65 that's taken out of every $100 you earn, $6.20 goes toward funding Social Security. By contrast, just $1.45 goes toward Medicare. In addition to what's withheld from your pay, your employer also has to match that amount with an additional $1.45 tax payment to go toward Medicare.
Most people resent the drain on their take-home pay from taxes like FICA. But as a study from the Urban Institute a few years ago noted, what you pay typically pales in comparison to the value you get.
How a small 1.45% tax adds up to big benefits
To come up with the amount that typical Americans make from their "investment" in Medicare coverage, the Urban Institute took a look at several different hypothetical households. The study included seven common situations, two of which dealt with single retirees, and four of which involved married couples. The study adjusted all prior taxes and future benefits for inflation, plus a 2% real return in order to avoid misleading comparisons, because people pay Medicare taxes long before they receive Medicare benefits.
The results were uniformly shocking. For a single man reaching age 65 in 2015 who earned the 2013 average wage of $44,800, Medicare taxes would add up to $70,000 over the course of a lifetime. But the benefits of Medicare would add up to $191,000, producing a net "profit" of $121,000. A single woman earning that same wage fared even better, as her longer life expectancy produced anticipated lifetime Medicare benefits of $230,000, boosting the gain to $160,000.
For married couples, when both spouses worked, the numbers were even larger, because they involved two people. For couples, when one spouse earned a higher-than-average wage of $71,400 and the other earned the average amount, benefits of $427,000 exceeded taxes of $182,000 by $245,000.
For couples, when both spouses earned the $44,800 average, they paid less in taxes, but got exactly the same benefits; their net gain was a larger $286,000. The hypothetical couple with an average earner and a low-income worker earning $20,200 paid just $102,000 in Medicare taxes to get exactly the same benefits, bringing the profit to $325,000.
The biggest difference came in the situation involving a one-earner couple. Non-working spouses are eligible for Medicare at age 65 as long as their working spouse is at least age 62 at that time. As a result, those spouses get exactly the same benefits while paying absolutely nothing in Medicare taxes. All told, a couple with one high-earning spouse making $71,400 will pay $111,000 in Medicare taxes, but get $427,000 in lifetime benefits, for a huge gain of $316,000. A couple with a single average-earning worker pays even less in taxes for the same benefits, with $70,000 in tax producing a net gain of $357,000.
Many people have criticized the study's findings, arguing that its methodology must have ignored some of the costs of Medicare. But when you look at what the researchers actually did, their methods were surprisingly thorough. The study took both the employee and employer taxes into account in coming up with total taxes paid, with the assumption that employers reduced actual pay by the amount they paid on their employees' behalf to Medicare.
Others noted that most Medicare recipients have to pay monthly premiums once they become eligible. But the study takes those payments into account, as well, reducing the gross Medicare benefits paid out by whatever the participant pays in premiums.
After seeing these results, the obvious question is, how does Medicare stay afloat? The answer is that, unlike Social Security, Medicare gets funding from sources other than payroll taxes. Medicare Part B is funded largely by Part B premiums, and money directly appropriated by Congress. Most payroll taxes go toward funding Medicare Part A hospital insurance, and even that program gets some extra money from sources like income tax receipts on taxable Social Security benefits, and interest from trust-fund investments.
Seeing Medicare taxes go out year after year can be painful; but when you consider the benefits you get in retirement, the amazing thing is just how good a deal Medicare really is.