Fixing Social Security and Medicare Via Self-Imposed Means Testing

by: Roger Nusbaum

Over the weekend, I had an epiphany about Social Security and Medicare that I think can be part of the solution to their current situation. The idea has a couple of building blocks of understanding that, if agreed upon, make the idea more plausible.

The first building block is that, financially, the country has a lot of problems that must be addressed and no solution can be "fair" to everyone or can give everyone everything they want. An equitable solution should involve everyone giving up something.

You may not like that, but it is my starting point.

Why are there caps on how much money we can put into IRAs, 401(k)s and the like? I know the answer on a day-to-day level, but conceptually, should there be caps on how much we can put into qualified retirement plans?

My idea is to do away with limits on qualified contributions -- sort of. In 2010, we put $5,000 into a contributory IRA for my wife as a non-working spouse (she volunteers more than full-time in dog rescue); $6,150 into our HSA; and 25% of my income (simplified explanation) into my SEP. We also let a fair bit (relative to our circumstances) accumulate in our taxable account. We can write off the first three but obviously not that last one. The idea then would be that we could put as much as possible into my wife's account and the SEP (HSAs work a little differently), such that anything above the limits is deducted from our future Social Security and Medicare benefits.

This would involve some actuarial/spreadsheet work, but maybe we could have put another $25,000 into our IRA in this context. This would have allowed us to reduce our taxes by quite a few thousand dollars while increasing our savings and reducing our Social Security benefit in the future. Doing this every year, the way I am thinking, would reduce our benefits to zero in all likelihood ... but leave us with more saved.

So far, this sounds like a perk for the wealthy. Here is where everyone has to give up something. People in a position to do this would be saving more, writing off more on their income taxes, phasing out their benefit, but continuing to pay the same $16,000 in FICA every year. So they would be paying in the same amount and losing some or all of their future benefit, in return for saving more and writing off more. Continuing to pay the full FICA may not seem fair, but a real solution should be uncomfortable for everyone (repeated for emphasis). As an incentive for retiring later, maybe people could stop paying FICA when they turn 65 or 70.

Given the savings problems the U.S. has, there are not a lot of people capable of participating. But if something like 10% of the population could do this, then it would relieve a substantial portion of the burden on the system; it would likely boil down to more than 10% in dollar terms, as most people doing this would be likely to otherwise qualify for the maximum benefit. Another element to this that I would add would be to make the penalties for early withdrawals from qualified accounts far more aggressive -- bordering on usurious -- except for medical events.

Making the penalties so stiff would hopefully send a message that this is serious business, and that once your money goes in, it does not come out except for a medical event for you, your spouse or your kids (I am very forgiving on this issue).

As opposed to just being a perk for the wealthy, people involved are giving up a lot of security (assuming the entitlements survive), but are getting the chance to be more self-sufficient. A conceptual drawback to this for me is that I think privatizing Social Security across the board would be disastrous, with 401(k) results from the last 11 years as exhibit A. A solution here could involve serious education, having to pass a competency exam, a combo of both, or any other idea deemed as practical.

This is probably obvious, but I personally would jump at the chance to opt out one way or another -- but I also believe that with the mess we have, no one should get off scott-free. Maybe I am wrong, but I think with this idea people still have incentive to work, make as much as they can and save as much as they can ... with at least an acknowledgment that we do stupid things sometimes with our money.

So is there a starting point here for contributing to a solution? Obviously, I am predisposed that it is a great idea. But while blogs customarily lend themselves to negative comments, if this can be a starting point, how can it be improved to become something workable? Why not a grassroots solution? If this self-imposed means testing makes any sense, then maybe we can spread the idea and get it to where it needs to go to be implemented.