Ten Steps to Reforming Baby Boomer Retirement
Thursday, March 23, 2006
by John C. Goodman, Devon Herrick, Matt Moore
Table of Contents
- Executive Summary
- Step 1. Improving Traditional Pension Plans
- Step 2. Improving 401(k) Plans
- Step 3. Expanding IRAs
- Step 4. Removing Penalties on Work
- Step 5. Repeal the Social Security Benefits Tax
- Step 6. Using the Roth Method of Taxation
- Step 7. Making Health Insurance Portable
- Step 8. Tax Relief for Post-Retirement Health Insurance
- Step 9. Creating Health Savings Accounts for Seniors
- Step 10. Paying for Long-Term Care
- About the Authors
Step 8. Tax Relief for Post-Retirement Health Insurance
Because health costs tend to rise with age and because people who retire prior to Medicare eligibility often find health coverage unaffordable or unobtainable, they often seek help from former employers. Nearly four in 10 large employers (38 percent) provide health insurance for retirees (usually comparable to benefits available for active employees) from the time of retirement until age 65 (when they become eligible for Medicare).44 Beyond age 65, many employers also provide insurance that supplements Medicare. Of large firms that offer retiree benefits, 93 percent offer them to early retirees while 78 percent offer them to Medicare-eligible retirees. 45
Unfortunately, there are two major problems with way the current system treats early retirees: (1) The employer's decision generally must be all or nothing and (2) employees who do not receive employer-provided, post-retirement health care benefits get virtually no tax relief if they purchase their own coverage.
Suppose General Motors is spending $11,000 per year on health insurance for active employees, on the average. If the company decides it cannot afford an equivalent amount for each retiree, why not offer, say, half that amount to retirees to be applied to less comprehensive health insurance that they buy on their own, or that could be deposited in a Health Savings Account (HSA) to purchase health care directly?
"Tax law penalizes individuals who purchase their own health insurance."
The problem is the tax law. Although GM can purchase health insurance with pretax dollars, it generally cannot give money to retirees to pay their own premiums with pretax dollars, nor can it give retirees pretax dollars to be deposited into an HSA. This all-or-nothing approach imposed by federal tax law may be one explanation why so many employers are ending post-retirement health care altogether. Nearly two-thirds (66 percent) of large employers offered retiree health benefits in 1988. By 2003 this proportion fell to 38 percent.46
"The elderly pay half their health care costs out of pocket."
Another problem with the tax law is that it gives virtually no tax relief for retirees who purchase their own insurance. One solution is the system of individually-owned, personal and portable health insurance discussed previously. Short of that reform, there are more limited reforms that would help. At a minimum, employers should be able to allocate pretax dollars to retirees up to the amount spent on active workers - provided that the funds are spent on health care. Retirees should be able to use the tax-free funds to purchase individual health insurance or deposit them in tax-free HSAs.
We also need tax relief for retirees' insurance costs not paid by employers. This tax relief could come in the form of an income tax deduction or a tax credit. The difference is that a tax deduction reduces the income upon which taxes are paid, whereas a tax credit is a dollar-for-dollar reduction in taxes owed. A tax deduction is more valuable to taxpayers in higher tax brackets because they are taxed at a higher rate and they are more likely to itemize deductions (which is required in order to receive the tax benefit). A tax deduction is less valuable to families in lower income tax brackets because they are taxed at a lower rate and they are less likely to itemize. For those families, a tax credit for health insurance would be of more benefit.