5 Must-Know Facts About Medicare

By Markets Fool.com

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Medicare isn't exactly in the best financial condition -- in fact, it's expected to run out of cash reserves in a little over a decade. However, Medicare isn't as "broke" as you may have heard, and it's important to separate fact from fiction. Here's what you need to know about the current state of Medicare, what would happen if it ran out of money, and what could be done to fix it.

1. Our seniors are highly dependent on Medicare

Medicare provides health coverage for more than 55 million beneficiaries as of 2015 -- virtually all of the retired 65-and-over population. Enrollment is projected to reach 64 million by 2020 and 80 million by 2030 as baby boomers retire.

Nearly half of beneficiaries have three or more chronic conditions, and they rely heavily on Medicare to afford essential medical services. Many beneficiaries have limited means to pay for healthcare expenses themselves: 48% of the elderly population is considered "economically vulnerable" with incomes lower than twice the federal poverty line.

It's fair to say that our senior citizens need Medicare.

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2. Don't let anyone tell you Medicare is broke

The Medicare Hospital Insurance Trust Fund had $197.3 billion in reserves at the end of 2015. Hospital Insurance expenditures were about $278.8 billion in 2015, the vast majority of which was financed by payroll taxes and interest earned on the trust fund's reserves. Just $3.5 billion of the expenses came from the redemption of reserves.

Furthermore, the Medicare Hospital Insurance program is actually expected to operate at a small surplus from 2016 through 2020. After that time, deficits are projected to resume for the foreseeable future, and reserve redemptions will again be necessary to meet the program's costs.

I examined the reasons for the projected deficit in another article, but in a nutshell, Americans are aging rapidly, and not enough people are paying into the system to take care of the number of people expected to start receiving benefits over the coming decades.

3. But it will be out of reserves in a few years

The 2016 Medicare Trustees' Report projects that the Hospital Insurance Trust Fund will be completely depleted by 2028 -- two years earlier than originally projected.

It's important to mention that this trust fund only covers Medicare Part A, which helps pay for hospital stays, home health services, skilled nursing facilities, and hospice care. There is another Medicare trust fund known as the Supplementary Medical Insurance Trust Fund, or SMI. This pays for Parts B and D, which cover physician stays and other services, as well as prescription drug coverage for those who have voluntarily enrolled.

Since this trust fund is financed through beneficiary premiums and general revenues, not payroll taxes, it will remain adequately financed for the foreseeable future. So, when we're talking about the Medicare funding problem, we're only referring to Hospital Insurance (Part A).

4. The worst-case scenario

If the Medicare Hospital Insurance Trust Fund runs out of money, then the incoming tax revenue will still be enough to cover 87% of the program's costs. So, as a worst-case scenario, a 13% cut in Medicare Hospital Insurance expenses would be necessary.

That said, a 13% cut would be a big deal to retirees. If the beneficiary has to pay an additional 13% out of pocket, then that could mean spending thousands more on a hospital stay, for example. As is, Medicare beneficiaries already spend more than $3,000 out of pocket on healthcare expenses each year on average. So, to be perfectly clear, this would be a major problem.

5. A tax increase might be necessary to fix it

The projected Medicare Hospital Insurance Trust Fund's 75-year projected actuarial deficit is 0.73% of taxable payroll. In other words, by raising the Medicare tax rate from the current rate of 2.9% (1.45% each for employers and employees) to 3.63% (1.815% each), and maintaining the additional Medicare taxes on high earners and certain investment income, the program would be fine for another 75 years.

This would represent an increase of about 25% in the Medicare taxes paid by most Americans, but it wouldn't be an unprecedented increase. In fact, in 1981, the Medicare tax rate was increased from 1.05% to 1.3% -- a 24% jump.

It's also worth mentioning that a tax increase wouldn't be the only way we could fix Medicare's funding shortfall. For one thing, the age of eligibility could be increased to 66 and then gradually to 67, in line with the Social Security full retirement age. About 16% of the Medicare population was between 65 and 67 in 2010, so this could have a big impact. We could also allow Medicare to negotiate drug prices, which is currently prohibited. Or we could implement some combination of a tax increase and other fixes.

There's time to decide -- but not much

Medicare isn't in the best financial shape right now, but we still have 12 years before anything would have to change, benefit-wise. Hopefully, lawmakers won't wait until the last minute to solve the problem, but if history is any indicator, some sort of fix will be made -- even if it's only temporary -- because Americans rely on Medicare.

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