State Pensions…the real problem is the cost of retired employees healthcare
After many years of hearing or reading about the occasional ‘expert’ pontificating or bloviating about the pension crisis in America, it seems more taxpayers are starting to pay attention to this under reported issue. To be more specific, many states do not have adequate funding of their pension system for public employees.
A couple of examples of this awakening to a very large problem are:
From Maui News.com, in its article titled “Maui budget crisis has begun”, the residents there have just learned that they will be paying “a total of $36 million in extra payments over the next four years alone to help fund the pension system of Hawaii.
Mr. Mauldin stated that “in the next 20 years, we’re going to see changes that humanity has never seen before, and in some cases never even imagined, and we’re going to have to change. I truly believe this. We have unleashed economic and technological forces we can observe but not entirely control.”
Why is Mr. Mauldin is taking this stance? It is simple. He called it a “bubble in government promises,” which he thinks “is arguably the biggest bubble in human history.” Mr. Mauldin reminded us that this bubble was created by “elected officials at all levels,” who have “promised workers they will receive pension benefits without taking the hard steps necessary to deliver on those promises.”
It’s not just the investment or income side that makes John Mauldin spot on. Where it becomes even more frightening is that many states made large promises to their employees in terms of healthcare. To be more specific, older retired public employees were promised that the state would pick up the tab for their health coverage as well as their spouse. This was the return or ‘compromise’ for working for the state at possibly a lower salary when compared to what they could earn in the private sector.
Because of this, many of these older public employees never paid into the Medicare system and now they do not qualify for the bulk of that cost to be “premium free” in retirement so dropping this benefit due to increases in costs is not really an option. If the retiree does not pay into Medicare while they are working, the Medicare Part A premiums when they retire and reach at 65 or older is $413.00 a month per person (2017 amount).
About a handful of states, New York being one of them, picks up Medicare Part B base premium that is deducted from one’s Social Security benefit. Depending on the system in NY, your pension is increased slightly to offset the Medicare premiums or the pension system cuts a check to the beneficiaries for the amount. Their public employees are also funding Medicare A. So the above scenario will not apply, other than a reform might take away the Part B reimbursement.
For the rest of Americans who work in the private sector, there is tax taken out of their wages to fund for Medicare Part A premiums when they retire and reach at 65 or older. As mentioned above, this premium is $413.00 a month per person in 2017.
The problem is getting larger as each year passes because Medicare premiums continue to increase. Medicare, on average, has inflated at roughly 7.5 percent since inception. Given overall healthcare spending and the graying population, that growth rate may remain constant for a little bit longer.
An example of where we may be headed as a nation may be seen in the state of New Jersey, where there may be larger ticking time bomb than what is being reported. According to the state of New Jersey’s Transparency Center, there are roughly 305,000 retired public employees who are receiving not only pensions, but who may also be receiving coverage for their healthcare as well.
In the state of New Jersey, according to NJ Department of Pensions and Benefits, those who have 25 years of service and who were employed before July 1, 1997 qualify for paid health coverage throughout retirement.
Of the 305,000 public retired employees reported by the Transparency Center, roughly 236,000 of them, as of 2018, will be between the ages of 65 to 90. That qualifies them for Medicare coverage. To be fair, the report from the Transparency Center is not specific if every one of these retired public employees qualify for full Medicare coverage. Some may not have worked long enough to qualify for Medicare, or they may have opted to have health coverage through a spouse. Nevertheless. the numbers are frightening.
If the state of New Jersey is in fact on the hook for covering this promise for all of those retired public employees on the books, roughly 236,000 of them, the liability for this promise will total over $379 million in 2018 before any other possible surcharges are added to Medicare. This is calculated by multiplying the retired employees by the baseline Medicare premiums of $134.00 a month per person (2017).
Compounding this problem are the changes to Medicare over the last two decades. Medicare is now means tested through its Income Related Monthly Adjustment Amount (IRMAA), which assess a surcharge on top of Medicare Part B and Part D premiums for those who are earning too much income.
The 2017 IRMAA brackets are as follows and are subject to be changed in 2018::
The income that Medicare uses to determine who is subject to these surcharges is defined as any “adjusted gross income plus any tax-exempt interest or everything on lines 37 and 8b or the IRS form 1040,” which means, unfortunately for the state of New Jersey, that pension income is also counted when determining who pays more for coverage.
And believe or not the state of New Jersey, as well as more than a few other states, have incorporated a regulation that reimburses any retired public employee who happens to reach Medicare’s IRMAA surcharge.
Of those 236,000 retired public employees 3,466 are earning an annual pension greater than $85,000 while 789 are in the 2nd Medicare IRMAA bracket and 10 are in the 3rd Medicare IRMAA bracket as they are taking home over $160,000 annually in the form of a pension. The surcharges for New Jersey are just north of an extra $3.7 million to Medicare due to retired public employees earning too much income through their pension.
Please note, that under federal regulations any surcharges that are accrued through Medicare’s IRMAA are not deposited back towards Medicare, but they are deposited directly back into the General Fund of the U.S. Treasury. That means the additional surcharges could help the government pay down the debt or allow Congress to spend more on non-healthcare related expenses.
Ultimately, the state of New Jersey could be on the hook of having to cover over $382 million annually in Medicare premiums for its retired public employees and their spouses, if, again, every one of them qualifies for coverage. Even if the number of retired public employees is cut by more than 60 percent, the amount of this specific obligation is one that each state, especially New Jersey, will not be able to maintain.
These problems are not limited to New Jersey. The problems surrounding the unfunded pension liability of individual states is a lot larger than has been reported. Many states that have made these promises are now starting to find themselves in the difficult position of having to figure out how to pay for this.
Mr. Maudlin was spot on in his assessment. In the next 10 to 20 years individual states will have to make a difficult choice of either funding promises that should be fulfilled while also trying to keep their government afloat, or opting to drop coverage all together for everyone to save itself. Why is this scenario likely over the next 10 to 20 years? Demographics. We will continue to see the wave of baby boomers (and older generation x) turning 65 and retiring. Keep in mind, public sector works may retire before age 65 if they have the years of service per their contracts.
If this scenario pans out as predicted, many retired public employees could be faced for having to pay not only for Medicare Part B, $134.00 a month, and Part D, roughly $53.17 a month on a national average, but also another $413.00 a month for Part A too. Even if retired public sector employees pay into Medicare Part A and their state pension system drops Part B and Part D coverage, it’s still a large and unexpected retirement cost that will cut into retirement income.
The consequences for not planning for health coverage in retirement have now become far more dangerous than anyone has ever thought.
Dan McGrath is considered to be a leading authority on the subject of how health related costs in retirement will affect both retirement as well as the overall the financial planning process. Mr. McGrath has also authored the bestselling retirement planning book “What you don’t know about retirement will hurt you” as well as “Medicare: A Practical Guide to Understanding Your Health Coverage in Retirement”. http://www.jesterfinancial.com