In response to the recent burst of inflation, the government increased Social Security benefits significantly in the past two years. But compared to average pre-retirement income, net benefits have been falling for decades. And the trend will continue. One big reason: Rapidly rising Medicare premiums that usually are deducted directly from Social Security checks.
Think about Social Security benefits in terms of how much of an average wage the retirement program covers. And despite steady increases in gross benefits, by this “replacement rate” measure, net Social Security benefits are declining. In other words, Social Security is providing a smaller share of the cash income older adults need to maintain their pre-retirement standard of living.
According to the Center for Retirement Research at Boston College, in 1995 Social Security benefits replaced about 42 percent of average earnings. But by 2015, that share had fallen to 36 percent and by 2035 it will drop to just 30 percent. In 2023, Social Security paid about 35 percent of average pre-retirement earnings, according to the Center for Budget and Policy Priorities.
There are three reasons for this decline:
The rise in the full retirement age. Because Congress raised the age at which people collect full Social Security benefits from 65 to 67, those who still take Social Security at 65 receive less compared to their pre-retirement earnings.
Higher income taxes. Social Security benefits have been subject to income tax since 1984. And since 1993, up to 85 percent of benefits are taxed for single retirees with total income above $34,000 and for married couples making $44,000 or more. Because those thresholds are not adjusted for inflation or wage growth, the tax eats up more benefits than ever.
Higher Medicare premiums. For most older adults, Medicare premiums are deducted from their Social Security benefits each month. And because Medicare costs are rising so fast, they are absorbing a larger and larger share of their Social Security checks.
This is similar to the way wage growth is constrained because employers and workers pay more for commercial health insurance premiums.
For example, over the past decade Medicare’s basic monthly Part B premium rose from $105 to $174.70. For high-income beneficiaries, monthly premiums rose from $336 to $594. The average monthly premium for the Part D drug benefit is about $59 and the average monthly premium for a Medicare Supplement (Medigap) policy is about $137, though those premiums vary widely depending on the kind of plan you buy and where you live. Medicare Advantage managed care policies generally cost less.
On average, combined monthly premiums for Part B, Part D, and Medigap average $370, a nearly 20 percent bite out of the average monthly Social Security benefit of about $1,900.
Other Costs In Old Age
Of course, recipients do get something import for those Medicare premiums: Good health insurance. But, especially for older adults who rely entirely or mostly on Social Security, dollars taken out for Medicare is money they don’t have to cover other expenses.
That includes housing, utilities, transportation, food, and out-of-pocket health care costs. Even those with Medicare must pay deductibles and co-payments. On average, the federal Department of Health and Human Services estimates that a typical older adult spent nearly $7,000 on medical care in 2019, including insurance premiums.
Lower Social Security payments also mean older adults have less for long-term care, which generally is not funded by Medicare. About 60 percent of those over age 65 will need a high level of long-term care before they die, and they’ll spend an average of about $100,000 out-of-pocket for that assistance, according to my Urban Institute colleague Richard Johnson. About 6 percent will spend $250,000 or more over their lifetimes.
Seeking More Income
The declining replacement rate for Social Security and the rise in out-of-pocket costs for just about everything else is a big reason why Americans need to save for their retirement through employer-based programs such as 401(k) plans or Individual Retirement Accounts.
But many fail to save enough. Boston College researchers Anqi Chen and Alicia Munnell calculate the median retirement savings balance for an individual aged 55-64 was about $150,000 in 2022. In other words, half had higher balances and half lower.
That is a significant improvement over 2019 when median balances were about $120,000. But if $150,000 were turned into an annuity, it would pay out only about $800-a-month. Added to the average Social Security benefit, and after taking out just that Part B Medicare premium, that leaves an older adult about $2,500-a-month to live on. The average apartment rent in the US is nearly $1,500.
There are many different ways to measure replacement rates. Social Security mostly uses an average of adjusted lifetime earnings. But whatever version you use, taxes, a rising retirement age, and—especially—increasing health care costs are eating away at Social Security benefits. Future retirees need to know that and find ways to supplement the federal retirement program with their own savings.