As 2010 draws to a close, people in or nearing retirement face a particularly uncertain financial future. The government has approved a package of tax breaks, jobless benefits, and other stimulus spending. But these fixes will last only a year or two and virtually guarantee big shifts down the road. Meanwhile, the landmark health reform law will be under sustained legal attacks for years, adding to already existing questions about the effects of its implementation. Deficit reduction efforts appear unavoidable, if unpleasant. And the economic recovery continues its painfully slow progress.
No wonder retirement-age people keep working or are trying to get back into the work force. They're also continuing to reduce their use of credit and tighten up on spending. People are playing defense—cutting spending a bit now to reduce the odds of having to live even more frugally in the future. Looking ahead, here are five major unresolved money issues that are crucial to retirees:
Taxes. Current tax rates will be extended until the end of 2012, but then all bets are off. Deficit reduction proposals suggest two possibilities. If Congress can agree to sharply reduce or eliminate more than $1 trillion in current tax breaks, it would be possible to simplify and lower personal income tax rates and still reduce the deficit. If such agreement cannot be fashioned, personal income tax rates would need to be increased.
Medicare. Under health reform, projected increases in Medicare spending would be trimmed by some $500 billion in the coming decade. A good portion of that savings will come from lower federal subsidies to insurers who sell Medicare Advantage plans that supplement basic Medicare. This shift is already being felt—insurers have cut back on their offerings and some are reducing covered benefits. But the major deficit reduction plans so far proposed would make further Medicare cuts. On the plus side, health reform will begin next year to provide an expanded list of free preventive wellness exams and tests. Brand-name prescription drug expenses will also be reduced for many Medicare recipients. But while a healthier group of retirees eventually would reduce financial pressures on Medicare, it's not likely that such gains will appear soon enough to forestall higher Medicare insurance costs to retirees.
Social Security. The stimulus package will provide a one-year tax holiday that will cut the employee portion of Social Security taxes by two percentage points. This would cost the government $110 billion to $120 billion. This cut does not affect Social Security benefits, but it will increase pressure to make Social Security cuts part of a long-term deficit reduction program. One of the most likely reductions is a change in the annual cost of living adjustment (COLA) that would trim the size of future COLAs. This change could affect current retirees. Other major changes—reducing benefits, raising the retirement age, and increasing the wage base subject to Social Security taxes—are not expected to occur soon enough to have a big impact on current retirees. They might, however, effect people who are getting close to retirement.
Home prices. Historically, home equity has been a major retirement asset. But millions of retirees have not been able to make sound financial plans about their homes in recent years. Not only have housing prices been cut, there is little sense of when they may recover or by how much. Mortgage foreclosures are still occurring so slowly that it's hard to get a clear idea of where prices eventually will settle. Meanwhile, President Obama's deficit reduction commission proposed a big cut in tax deduction for mortgage interest. Even the possibility of such a cut may depress home values.
Inflation. Federal Reserve Chairman Ben Bernanke says he's 100-percent confident that the central bank can keep inflation under control. Unfortunately, he can't control the opinions of foreign investors, particularly in China. They own trillions of dollars in U.S. securities. If their opinion of our economic prospects is negative—and this clearly has been the prevailing view—they will demand higher interest rates to continue holding U.S. securities. As more U.S. dollars flow out to fund U.S. debts held overseas, the value of the dollar comes under pressure as well. And if it continues to fall, it will take more and more dollars to pay for oil and other imports. This can make U.S. exports cheaper and help our trade deficits. But it also will contribute to higher prices. In fact, heightened uncertainty over future inflation rates can itself contribute to higher inflation.