Get Ready to Kiss a Majority of Your Social Security Benefits Goodbye

The Social Security system has been providing a financial foundation for low- and middle-income retired American workers for more than 75 years, and over that time many retirees have come to rely on Social Security income to help sustain their ways of life during retirement.

A recent Gallup poll observed that roughly 3 in 5 seniors rely on Social Security for a major source of income. This data is confirmed by the Social Security Administration, which pointed out in October that 53% of married couples and 74% of unmarried persons receive at least half their income each month from Social Security. Whether you're already retired and receiving benefits or are heading into retirement very soon, chances are that Social Security income will determine whether or not you can meet your monthly expenses in your golden years.

Kiss your Social Security benefits goodbye

However, many seniors could be in for a rude awakening if they're solely or largely dependent upon Social Security income in retirement. You're probably well aware that the Social Security program is on an unsustainable path that'll likely see the Trust's cash reserves exhausted by 2034, potentially necessitating a hike in payroll taxes for working Americans, a cut in benefits of up to 21% (hardly what retirees dependent on Social Security want to see), or some combination of tax increases and benefits cuts. But there's a far bigger problem brewing: rising healthcare costs.

Once seniors hit the magic age of 65 they're eligible to enroll in Medicare, which is a smart move since Medicare may be able to save seniors money over private health insurance plans. While Medicare Part A, also known as hospital insurance, is typically free for seniors who've amassed enough work credits, premiums associated with Part B (medical/outpatient services insurance), Part D (prescription drug plan), and Part F (a Medigap policy that fills in the "gaps" of what you might owe for Part B) are on the rise.

According to the Medicare Board of Trustees, Part B premiums are projected to increase by 5.76% annually through 2024. Likewise, Part D premiums are estimated to move higher by 7.1% annually. Medigap policies are the exception to the rule, with a reasonable expected inflation rate of 3.25% through 2024. Part B premiums are almost always taken directly out of a senior's Social Security benefits (assuming they've filed for benefits), while consumers can request their Part D premium be taken directly from their benefits as well.

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Now here's where things get scary. Based on estimates from the Social Security Board of Trustees, the average cost-of-living adjustment (COLA) going forward isn't expected to be higher than 2.7%. COLAs typically follow the rate of inflation in the U.S., and following the Great Recession we've had low levels of inflation. In fact, in 2009, 2010, and 2016, there was no increase in COLA whatsoever, meaning no boost in benefits to retirees. By comparison, the average costs associated with Medicare are expected to rise by 5.35% annually, which is essentially double the Social Security's COLA -- and we predominantly have specialty and branded therapeutics to thank for that increase.

According to Dan McGrath, co-founder of Jester Financial Technologies, the average Social Security beneficiary is paying about $4,300 in 2016 to be fully covered by Part B, Part D, and Part F under Medicare. By comparison, the average retired worker is only receiving around $16,100 in annual benefits this year. This would mean Medicare payments are consuming 26% of retirees' Social Security income. However, with medical expense inflation vastly outpacing national inflation measures, within 10 years seniors can expect to be paying 40% of their Social Security benefits to Medicare, and by age 85 (20 years from first enrollment) this figure is estimated to jump to more than 55% of their annual benefits. 

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The outlook is even grimmer in HealthView Services' 2015 Retirement Health Care Costs Data Report. Using a fictitious 66-year-old couple with a Primary Insurance Amount of $25,332 as its example, and assuming a Social Security COLA of 2% per year, HealthView Services calculates that between age 70 and age 87 the percentage of Social Security income dedicated to healthcare costs will rise from 43% to -- I hope you're sitting down -- 89%! Comparatively, the amount of Social Security benefits left over after healthcare costs are accounted for in HealthView Services' model drops from $18,651 at age 70 to just $5,018 by age 87.

You're going to need a plan B

Based on these estimates, it's pretty clear that whether you're decades away from retirement or approaching it quickly, you're going to need to have a plan B in place to help cover your monthly expenses beyond just Social Security, because we simply can't count on prescription drug reforms to fix everything.

Arguably the smartest move consumers can make is opening, or contributing to, a Roth IRA. Not everyone can contribute to a Roth, as there are income limits in place for upper-income earners. Then again, if you're an upper-income earner you're probably not having issues meeting your medical coverage costs in retirement. But if you can contribute to a Roth IRA (and most people can), it can offer a few major advantages.

The biggest benefit of the Roth IRA is that your money can grow completely tax-free for life. Since this money is tax-free, it doesn't count against any of the income parameters for Medicare. For example, Part B and Part D premiums can escalate -- meaning you'll pay a surcharge -- if you earn too much money. No matter how much you withdraw from your Roth IRA, however, it'll never count toward your annual income.

Roth IRAs also have no required minimum distribution amount, meaning you can let your nest egg continue to grow for as long as you want, and unlike a Traditional IRA you can continue to make contributions to a Roth beyond the year in which you turn 70-1/2. Since people are living longer than ever, this means more time for your nest egg to grow.

There are other options that would work as a plan B as well, including a 401(k), a Traditional IRA, or an investment account. Just be aware that these options can, at best, defer your tax liability. Once you begin making withdrawals, or selling stock in an investment account, that income could cause you to pay a Medicare surcharge for Part B or Part D, thus increasing your Medicare-based expenses.

Regardless of the path you choose, just understand that Social Security alone probably isn't going to be enough to sustain your current way of life due to the rising costs associated with Medicare.