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Is 2011 The Beginning of the End for Medicare?

In 2011 the oldest Baby Boomers turn 65 and hit yet another milestone: they become eligible for Medicare. AARP estimates 2.5 million more Americans will become eligible for Medicare this year, increasing the ranks of the 65+ plus contingent by 6 percent in 2011 alone.

But that's just the beginning of the boomer deluge facing the Medicare program -- and our federal budget -- over the next 20 years. As the red bars in the chart below show, it is Medicare and Medicaid, not Social Security, that looms as the biggest federal budget buster in terms of its growing demand on federal dollars.

In 2010, 21 percent of federal spending went to Medicare and Medicaid; by 2020 it's expected to reach 31 percent. The fact that Boomers will be swelling the ranks of the Medicare-eligible is just one factor; health care costs, which are growing at a much faster pace than the general rate of inflation, are another big culprit as well.

But the bottom line is that all Americans -- not just Boomers getting ready to sign up for Medicare -- must recognize Medicare is the really big federal deficit elephant in the room. What we're all paying into the system through payroll deductions is in no way close to the amount of Medicare benefits we will consume.

A new analysis by Eugene Steuerle and Stephanie Rennane at the Urban Institute estimates that, on average Americans will receive about three times more in benefits from Medicare than they paid into the system. The researchers estimate that a couple retiring this year that earned average wages throughout their work life would have paid $114,000 in Medicare payroll taxes during their careers. And based on average life expectancy, that same couple will "collect" an estimated $355,000 in Medicare benefits.

While Social Security seems to be the most popular target whenever the topic of conversation involves the role of entitlement programs and the federal deficit, Medicare is actually the bigger drain on our federal coffers. Steuerle and Rennane estimate that the same average-wage earner couple will have paid about $614,000 into the Social Security system during their work years, but will collect about $555,000 in Social Security benefits. That's a 10 percent differential and one where expected benefits are actually less than contributions, compared to a 211 percent differential where expected Medicare benefits are much more than contributions, according to the Urban Institute's analysis.

And that's going to create a debilitating drain on federal spending. The Congressional Budget Office estimates that spending on Medicare and Medicaid will balloon from 7 percent of gross domestic product in 2020 to 12 percent in 2050.

The End of Medicare as We Know It?
Clearly, Medicare must be a part of any serious Washington debate about how to rein in the federal deficit. It will be interesting to see if it indeed gets any serious Congressional attention in 2011. While Medicare reform was included in the two main deficit-cutting plans floated in Washington last fall, its not clear to what extent deficit reduction -- let alone Medicare spending -- will be addressed in Congress this year.

But with the Republicans now in the majority in the House, it could in fact make it to the table. Representative Paul Ryan (R-Wis.) is the new chair of the House Budget Committee, and Medicare reform is definitely on his radar. Last November, Representative Ryan teamed up with Alice Rivlin -- a member of both the President's deficit commission and the deficit task force of the Bipartisan Policy Center -- to float a massive overhaul of Medicare.

The Rivlin-Ryan Medicare reform proposal centers on a voucher program that beginning in 2021 would give every Medicare-eligible American a payment that they would use to purchase private insurance. The amount of that voucher would be based on average annual per-person Medicare spending in 2021, and annual increases would be limited to no more than the rate of GDP growth plus one percentage point. That's a lot less than the current annual growth rate in health insurance costs. Moreover, high-income seniors would only be eligible for a smaller annual increase. The upshot of this proposal is that if your voucher amount doesn't buy you the level of insurance coverage you want, well, the rest would need to come out of your own pocket. Rivlin-Ryan would also raise the Medicare-eligibility age from 65 to 67.

The CBO took a spin through the Ryan-Rivlin plan and estimated it could mean Medicare spending would be 10 percent of GDP in 2050, compared to the CBO's current estimate (using its extended baseline scenario) of 12 percent.

To be sure, Rivlin-Ryan is just one plan that has seen the light of day, but a common theme throughout all proposals is that the program would require seniors to cover more of their retirement health care costs. For example, the Bipartisan Policy Center's deficit reduction proposal (the Domenici-Rivlin plan) recommends that the Medicare Part B premium paid by individuals increase to cover 35 percent of the program's total costs (currently these premiums finances 25 percent of Medicare costs).

What You Should Do
While there's no clear timetable for when Washington might buckle down and attack the deficit problem, it seems pretty likely that when that occurs, Medicare will have to be part of the conversation. Today's 65-year olds likely have little to worry about; entitlement reform is typically phased in over years. But everyone else should be facing up to the fact that you will be on the hook for covering more of your health care costs in retirement. And even without reform, that should already be a big-ticket line item in your retirement budget.

According to the Employee Benefit Research Institute, a couple retiring in 10 years might need north of $650,000 to cover their out-of pocket medical expenses in retirement. And that figure does not include any potential changes to Medicare. If that just raised your blood pressure, and you're over 50 years old, you should consider ramping up your 401(k) and IRA contributions. In 2011, anyone at least 50 years old is allowed to contribute an extra $5,500 a year into their 401(k) and another $1,000 catch-up is allowed on IRA contributions. Manage to save that extra $6,500 a year from age 50 to 65 and at a conservative 3 percent annualized return, you could have yourself an extra $250,000 ready to pay some of your medical costs that aren't covered by Medicare.

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