The Future of Social Security and Medicare?

The clock is ticking on two pillars of retirement planning. Barring major overhauls, projections indicate that Medicare's Hospital Insurance trust fund, which covers hospital benefits, will be unable to pay full benefits after 2036, and the Social Security trust fund, which covers retirees and their survivors, will be unable to pay full benefits after 2033.

We talked with Mike Townsend—managing director of legislative and regulatory affairs at Schwab—about the most likely solutions, whom they'll affect, and when.

Mike: There's a universe of possibilities, including extending the full retirement age, raising the payroll tax rate, and increasing the amount of income subject to the payroll tax. But no one in elected office is enthusiastic about promoting any solutions that might prove politically unpopular.

Mike: During the last major Social Security overhaul, in 1983, the age at which you could collect full benefits was gradually increased, from 65 to 67. (You can collect reduced benefits as early as age 62.) We're seeing similar proposals now, with one pushing for a full retirement age of 70 for those born after 1977—the rationale being that people are generally living longer and therefore also working longer. This is at or near the top of the list of proposals, and it's likely that the full retirement age will go up at some point—though I expect it will include a long and slow phase-in when it does happen.

Mike: Currently, the payroll tax that funds retiree benefits is 12.4% of workers' earnings, split evenly between employer and employee. There are many proposals to increase that amount, such as by a fraction of a percentage point annually over several years to lessen the impact on the average worker.

Mike: For 2024, only the first $168,600 of income is subject to the Social Security payroll tax. One proposal suggests starting to collect the tax again for income over $400,000, while another suggests collecting above $250,000. On the political left, that's probably the most popular proposal, because it impacts higher earners; but on the right, it's among the least popular proposals because conservatives generally oppose tax increases of any kind.

Mike: There's a bipartisan group in the Senate trying to come up with alternatives. For example, Social Security funds are now 100% invested in U.S. Treasury bonds, which are very safe but offer a relatively low rate of return. One idea is to put some portion of Social Security taxes into a newly created sovereign wealth fund that would invest in stocks and have the potential to earn a higher rate of return.

Mike: The Medicare payroll tax of 2.9%, which is split equally between employers and workers, finances this fund. For wages above $200,000, there's an additional Medicare tax of 0.9%. Raising the tax is one way to help shore up Medicare, so it's definitely in the mix. But again, in a divided Congress the more conservative members are unlikely to vote for a tax increase.

Mike: Currently that tax is 3.8% on investment income for those making a total of more than $200,000 ($250,000 for married couples filing jointly). Right now, that money goes into the general coffers rather than Medicare. However, President Biden has proposed not only an expansion of the tax—to 5% above $400,000 in income ($450,000 for couples filing jointly)—but also to apply the money to the Hospital Insurance trust fund. That proposal is also going nowhere in a divided Congress, but it's nevertheless on the table.

Mike: The closer the government gets to the insolvency deadlines, the less time it has to raise the necessary funds. Congress can continue to kick the can down the road, but the math is only going to get more difficult. That said, there continues to be a lack of urgency on Capitol Hill, and it may be a few years before momentum for action builds.

From a beneficiary's perspective, any proposed solution likely would be phased in over many years—and people approaching or already in retirement would almost certainly be exempt. After all, many Americans have been planning their retirement with certain assumptions around Social Security in mind, and it would be unfair to upend those assumptions without adequate time to adjust.