Not much retirement security from government

/ Source: Business Week

Federal entitlement programs are critical to retirement security, but these programs are rapidly moving into the red. New projections by the trustees of the Social Security and Medicare trust funds released May 11 indicate that both funds will run out of money even sooner than estimated in last year's report.

The Social Security trust fund is in better shape than Medicare. Revenues still exceed benefits by a comfortable amount. Unfortunately, the wave of baby boomer retirements will change that picture. The new trustees report still expects the surplus to continue until 2015 but move into deficit thereafter. This report projects that by 2037, revenues will be only 75 percent of benefit payments.

An increase in average retirement age could help extend the period of surplus, but probably not by much. If workers delay retirement, they will continue to pay taxes into the system and not take money out, but when they do retire they will also get higher benefits. A net improvement in the trust fund results, but the change mostly delays the problem rather than reduces it.

Filling your IRA with IOUs from you
Current projections suggest the trust fund will run out of money in 2037. This would be a more relevant date if the trust fund had any funds in it. However, it contains only Treasury securities, that is, promises from the government to pay itself. This amounts to funding your IRA by filling a cookie jar with IOUs from yourself. The stream of revenue is real, but the IOUs are at best only a moral promise to keep paying benefits, which arguably will still exist after the trust fund runs out.

In our view, the Social Security trust fund projections are extremely solid at this point. Numbers could change slightly because of inflation and cost-of-living adjustments, but any reduction in benefits would likely be matched by reduced revenues because of lower wage growth. The underlying problem is that today there are five workers for every retiree; in 20 years, there will only be three.

One possible solution is to raise not just the average age of retirement but also the age at which full benefits can be collected. Under present law, new retirees can collect full benefits at age 66, scheduled to gradually rise to 67, depending on date of birth. Increasing it still further could help, since it would reduce benefits to early retirees and augment revenue by keeping people in the workforce longer. This eliminates the offset of paying higher benefits to later retirees.

Medicare estimates more error-prone
It's doubtful that raising the age for collecting full benefits is politically feasible, but it may be less politically suicidal than the alternatives.

Medicare is in far worse shape than the Social Security trust fund. The Medicare Hospital Insurance fund is already running a deficit, and the trust fund (again only a notional entity) will run out of money in 2017 under current projections. Any decision by workers to delay retirement has even less impact on Medicare than on Social Security. It would increase revenue but would have little impact on benefits, since Americans become eligible for Medicare at age 65 even if they're still working.

Compared with Social Security's projections, the Medicare estimates are more subject to error, since they depend on forecasts of health-care costs in addition to projections of revenues and numbers of eligible recipients.

Fears are warranted
However, it's impossible to turn the estimates into good news even with the lowest plausible projections of cost escalation. If anything, the trustees' estimates look too optimistic, as they traditionally have been. Raising the age of eligibility seems even more of a nonstarter for Medicare than for Social Security.

Only 32 percent of workers are somewhat or very confident that Social Security will continue to provide today's level of benefits, and only 38 percent have similar confidence in Medicare, according to the 2009 Retirement Confidence Survey. A glance at the trustees' report suggests these fears are warranted. The most likely changes would be increased means testing (or income-based co-payments) or increased age of retirement, but lower general benefits are also possible. Means testing of benefits, however, has the unintended consequence of reducing the incentive to save, since additional savings will reduce your government benefits.