Spooning Out the Catfood: How Much Must You Save to Offset Proposed Cuts to Social Security, Medicare?
The average person needs to save at least $122.65 per month starting now to protect themselves from the Catfood Commission Co-Chairs’ recommendations. I’ve done a chart to help you figure out how much you need to save.
The Co-Chairs, Alan Simpson and Erskine Bowles, propose to cut Social Security benefits by increasing the retirement age and changing the formula for cost of living increases. The net effect of these changes is shown on Page 49 of their report (link above). For people whose income is in the middle quintile, lifetime median benefits will fall 8%. People will have to save to make up that loss.
Here’s an example. Suppose you are 42 years old, and earn the median wage. I estimate that is an income of about $47,000, based on the 2007 Federal Reserve Board’s Consumer Finance Survey (pdf), table 1 01-07. You plan to work to full retirement age, 67, and expect to live 20 years after that.
Retirement planners use charts like Table 2 on this page to estimate the amount of your Social Security benefits when you retire. Using that and interpolating, I estimate your annual benefits at $29,000, so your monthly loss would be $193. To make up that loss, you need to save $34,800 between now and retirement (I used this calculator), assuming you earn a 3% annual return in retirement.
If you manage this yourself, you will run out of money after 20 years, which would be a problem if you lived longer. If you buy an actual annuity, you have to save more, but you are protected if you live longer, and your heirs would get something if you died earlier. To be safe, let’s say you need to accumulate an additional $38,000. If you work the whole 20 years, you need to save an additional $85.20 each and every month for the entire time at 3% according to this calculator. Of course this is only an estimate. You have to watch inflation and your income going forward to make appropriate adjustments. . . . [cont’d.]
It’s much harder to figure out the costs of the proposed Medicare reductions. The Co-Chairs just say they want to increase cost-sharing, meaning they want to increase co-pays and require you to pay a percentage of the cost of treatment. The idea is that if it costs you more out-of-pocket, you won’t abuse the system.
Suppose the final number is 5% cost sharing and an increase of $10 in co-pays. According to the Medicare Trustees (pdf), the best estimate of Medicare expenditures is 4.28% of GDP in 2020 (page 16) . The CBO projects GDP of $23.4 trillion that year, (p. 30, pdf page 48), giving an estimate of $1 trillion in Medicare expenditures. A 5% cost-sharing rule would cost Medicare beneficiaries about $50 billion. The Census Bureau projects that there will be 61.5 million people of Medicare age in 2020, so your share of the $50 billion is $813 that year, increasing after that.
How much should you budget to pay that additional cost? Let’s say you see a doctor twice a year, for $20 in co-pays. You have to pay for your drugs, so let’s add an additional $500 of co-pay and cost-sharing on those. That gives an estimate of $1,333. Assuming again that you will live 20 years after retirement (assuming you begin to use Medicare then), you would need an additional savings of $20,029, and monthly savings of $37.45. Adding the Social Security savings, we get a total of $122.65.
The Medicare number varies from person to person, but one thing is clear, the weakest citizens pay more than the healthiest, so the sicker you are, the more you need to save.
How Much Should You Save?
The calculations are a bit complicated, so I did some estimates of how much you should save. I assume that you expect to live 20 years past your retirement. I use Table 2 of this page. The cuts are my estimates based on the draft report of the Co-Chairs, page 49.
I assume an interest rate of 3% both during the time you are saving and the time you are drawing down your savings. Most people will be in CDs or savings accounts, so the lower figure is more likely to be right for them. For people who can take some risks in the stock market, you might need to save less if you think you can get a higher rate of return.
I use three estimates of time to retirement — 15, 25, and 35 years. I do not add money to cover expenses or give a cushion. I use the above estimate for Medicare, which does include a cushion.
Although Table 2 does seem to include some changes for inflation, I doubt it will be accurate. As time goes by, you need to increase your savings to account for inflation, especially if you are a long way from retirement. Also, the farther you are from retirement, the more likely your income will change. This may require increased savings as well.
Good luck, fellow Americans, you are on your own.