Social Security, Medicare, Welfare: It's complicated
Q: Can you write a column that is headlined "Welfare in Trouble?" There must be potential shortfalls in the future for welfare since it is a totally unfunded program, unlike Social Security and Medicare, which is 100 percent prepaid by its beneficiaries. - M.Q., Austin, Texas
A: You aren't the only reader who wrote asking that question. But comparing Social Security and Medicare funding to welfare funding is missing the point. Neither Social Security nor Medicare is prepaid, let alone 100 percent prepaid, as you and many others believe.
Take Medicare Part B. By law, 75 percent of its costs are covered by general revenues. The other 25 percent is supposed to be covered by premiums.
Whether the entire Medicare program is fully funded depends on whether Medicare employment tax revenues and general tax revenues rise fast enough to offset actual costs. Right now, according to the chief actuary, we're operating with imaginary accounting that isn't related to the historical record of medical care costs. The result is a dramatic underfunding of the program.
Social Security has been a pay-as-you-go program from day one. The famed Social Security Trust Fund, in spite of its $2.8 trillion in assets, is only a vehicle to smooth out economic ups and downs and the retirement of the boomers. It grew to its current size as an effort to cover the rapidly rising
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costs when the boomers retired.
Part of the goal of the 1983 reforms was to put the program in actuarial balance for 75 years. But it's out of balance today by quite a bit. Employment tax revenues won't be enough to sustain estimated benefit payments when the trust fund is exhausted in 2034. So the money will have to come from somewhere - or benefits will have to be cut.
None of this is an evil plot. We've enjoyed enormous gains in life expectancy since the creation of Social Security. That means more people, spending more years in retirement, collecting Social Security benefits and visiting their doctors for treatments that didn't exist 50 years ago. Not to mention spending time in ever more expensive hospitals.
As a practical matter, both Social Security and Medicare can be considered as welfare for everyone, providing guaranteed benefits when personal savings and income aren't adequate.
So, let's not blame the funding problems we face on the poor. Instead, let's figure out how to pay for the blessing of having so many people able to enjoy longer lives.
Q: My wife recently inherited $200,000, and we are struggling with how to best use the money. First, let me tell you our financial status. My wife is 60 (not working) and I am 57. I make about $190,000 a year. I have an IRA valued at $230,000 and my current 401(k) is worth about $180,000.
Our home is mortgaged for $170,000 at 3.75 percent interest and is worth about $375,000. Our cars are also financed for about $40,000 at interest rates of 3 to 4 percent. We have about $13,000 in credit card debt at 6 percent interest.
My financial adviser at Wells Fargo is saying we should open a separate IRA for my wife to invest in Black Rock. My wife and I want to make best use of this windfall. Please help. - R.G., Houston
A: That's a good suggestion from your adviser, but you need to look well beyond a spousal IRA. Also, with your income at $190,000, the spousal IRA contribution won't be tax deductible since your income exceeds the Modified Adjusted Gross Income (MAGI) limit of $118,000. You need to increase your retirement assets quickly, which means saving more.
The inheritance, kept in tax-efficient investments in a taxable account, can be a major help in lining up your total retirement assets with your longer-term retirement income needs.
Before the inheritance, your savings were a bit over two years of gross income. Now they are more than three years. Fortunately, you've still got time to eliminate your debt and build your IRA and 401(k) plan assets to a larger multiple of your earned income.
Hopefully, your adviser will see the importance of investing this money in low-cost index funds, and of some amount of diversification.
With that done, you can focus on paying off your debt. While $13,000 in credit card debt is small compared to your income, there's just no reason to have any credit card debt at all. You should be just racking up the credit card travel miles and paying no interest.
• Scott Burns is a principal of the Plano, Texas-based investment firm AssetBuilder Inc., a registered investment adviser. Questions about personal finance and investments may be sent by email to scott@scottburns.com.
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