Medicare premiums may soon start crushing retiree spending power. I estimate that many a long-lived couple may need to reduce their retirement spending on non-medical consumption by 13 percent to 26 percent to avoid sharp declines in purchasing power as they get older.
This is not an alarmist fantasy. My estimates come from projecting historical cost rates into the 30-year retirement of a couple retiring this year.
Here are the basic facts. Since 1965, the year Medicare was created, the consumer price index has risen at a 4.5 percent annual rate. But the Medicare premium has inflated at an 8.4 percent rate over the same period. Worse, the gap appears to be growing.
Between 2000 and 2008 the monthly Medicare premium grew from $45.40 to $96.40.
You can understand what this means for real people by considering the future of an imaginary couple, Mr. and Mrs. Retirenow.
They both turned 65 in January. They have $10,000 in cash, $300,000 in IRA investments, and they own their $200,000 home in Texas, free and clear. He collects $1,200 a month in Social Security, slightly above average. She collects $600 a month in spousal benefits. Neither has a pension, but they think they can get along pretty well on $21,600 in Social Security benefits and $15,000 from their IRA accounts, a total of $36,600 a year.
They feel pretty safe about that $15,000 a year from their investments because they found they would get that much if they purchased an inflation-adjusted joint life annuity from Vanguard. They’ll leave the house to the kids, but nothing else.
Another reason they feel positive about their retirement is that they live in a no-income-tax state. They also don’t owe anything in federal income taxes. Finally, we’re going to assume that they earn 7 percent on their investments and that inflation runs at 4 percent a year--- a little less than it has been since they were in their early 20s and started working.
Just weeks before they retired, they figured they would spend $2,314 of their $36,600 income on Medicare Part B premiums and $8,200 paying the insurance, taxes, and operating expenses of their house. That would leave them with $26,086 to spend on everything else.
To be sure, they’d never be candidates for Lifestyles of the Hideously Rich and Notorious but, well, who cares?
In fact, their lifetime spending will be lower. While a portion of the reduction will come from a slowly increasing federal income tax bill, most of the reduction will be due to rising Medicare Part B premiums.
To find out how much lower, I used ESPlanner, the most powerful and comprehensive financial planning software available today. It’s also the foundation for “Spend ‘til the End” (Simon and Schuster, $26) the recently published book on financial planning I coauthored with Boston University economist Laurence J. Kotlikoff. ESPlanner, which I’ve mentioned in many columns, uses dynamic programming to actually solve the question most retirees ask:
How much can I spend and have a level standard of living for the rest of my life?
ESPlanner tells us that the Retirenows would have $24,460 a year to spend until they died at age 95, if Medicare premiums rose only at the general inflation rate. But with a long-term premium increase that’s nearly 4 percent higher, their spending power drops to $22,809. And if Medicare inflation continues to run 7 percent faster than inflation, their spending power drops to $21,289 a year, a reduction of 13 percent.
Since the growth of Medicare Part B premiums is likely to be paralleled by the growth of premiums for Medigap policies (which often cost about as much as the Part B premium), the lifetime loss of living standard over a long retirement is likely to be about 26 percent.
How will younger people who retire in the future be affected?
Sadly, the younger you are, the greater the impact of rising Medicare premiums because the premium is rising faster than both wages and Social Security benefits.
On the web:Consumption smoothing columns:
Spend ‘til the End on Amazon:
Vanguard inflation adjusted life annuity quote
What is dynamic programming?