It’s prudent not to count on Medicare and Social Security benefits in retirement planning

Two of the primary pillars of retirement security are not just on the ropes, but actually on life support.

Both Medicare and Social Security, which are the predominant sources of income and health care coverage for millions of retired Americans, are now on pace to run out of money even sooner than many people anticipated. Because of the economic crisis, Medicare is now set to tap out by 2017, two years ahead of the previously predicted date, while Social Security will exhaust all of its funds by 2037, four years earlier than previously calculated.

Advisers never like uncertainty when it comes to retirement planning — and of course, neither do clients. So there’s a simple way to address these massive question marks when helping clients map out their plans for retirement: Simply scratch both Medicare and Social Security from the retirement planning process.

More advisers are moving in this direction with their clients under the age of 50. And who can blame them?

If Social Security typically makes up about 20% of clients’ retirement incomes, and there’s a possibility it may no longer exist (at some increasingly imminent time), advisers shouldn’t be crossing their fingers and hoping the system somehow stays solvent.

Rather, advisers now need to be urging clients to save more and spend less while they’re actually still working. And, advisers should also be telling clients to start thinking about lowering their anticipated discretionary spending during their retirement. Clients’ basic retirement living expenses — their floors — could easily be greater than what most people currently expect, particularly if Social Security or Medicare take a hit or fail completely.

The mantra is to hope for the best, but plan for the worst.

Some advisers are encouraging clients to set up liquidity reserves to account for many of the expenses that could take them by surprise during retirement. That includes the constantly rising costs of health care, or the possibility that Social Security may disappear. (Most advisers seem to think that Medicare, even if it does eventually exceed its reserves, will exist in another form and retirees will have at least some access to basic health care coverage).

These are reserves that are set up in stable investment vehicles, such as money market accounts and certificates of deposits, or more conservative government bond funds. It’s hardly exciting investing, and the yields can be as exciting as watching paint dry. But that’s exactly the point: when saving to cover long-term uncertainties, eliminate the short-term uncertainties that are actually within your control.

It may sound bearish, but the economic crisis has highlighted the perils of buying what you can’t afford. And while you can borrow money for just about anything in this world — buying a house, a car or paying for education — no financial institution will float people a loan to fund their retirements (at least yet).

If Social Security and Medicare somehow survive, or the government finds alternative ways to subsidize income and health care coverage for retirees, then the clients who have set additional money aside to offset the absence of both will have, as one adviser to put it, a “retirement bonus.”

There’s simply too much risk associated with taking a wait-and-see approach on both programs. And the costs of under-saving clearly outweigh the risks of over-saving when it comes to retirement security.

So while advisers will never be able to eliminate all of the guesswork surrounding retirement planning, they can subtract two of the largest looming uncertainties — Medicare and Social Security — from the equation right now and start planning for a more certain future.

Mark Bruno is a reporter with InvestmentNews. He can be reached at [email protected].