How is Medicare Funded?

Medicare is funded by general federal tax revenue, payroll tax revenue and premiums paid by its beneficiaries.

Jeanine Skowronski

Jeanine Skowronski

Published July 16, 2018

Medicare, at its core, is a social health insurance program designed to help elderly Americans pay for medical care in retirement. Medicare is primarily funded by general federal tax revenue, specific payroll tax revenue, and premiums paid by its beneficiaries.

How Medicare is funded

Technically, Medicare bills are paid through two trust fund accounts held by the U.S. Treasury:

  • The Hospital Insurance (HI) Trust Fund pays for Medicare Part A benefits, which include hospital, nursing home, skilled nursing facility, hospice and home health care.
  • The Supplementary Medical Insurance (SMI) Trust Fund pays for Medicare Part B benefits, which include doctors’ visits for outpatients, mental health, ambulance and preventative care, and Medicare Part D, which is prescription drug coverage.

However, those trusts are funded by a variety of sources, including:

  • Payroll taxes paid by employers and employees, specifically the Medicare Tax
  • General federal tax revenue appropriated by Congress
  • Interest earned on the trust fund investments
  • Income taxes paid on Social Security benefits
  • Premiums paid by Medicare beneficiaries

As such, while Medicare is a form of social health care, it is not, in fact, free health care. American taxpayer dollars fund the program and beneficiaries pay premiums, deductibles and coinsurance or copays once they enroll. (Our partner Via Benefits can help you compare and buy Medicare plans in your area.)

Learn more about total costs beneficiaries pay for Medicare.

What is the Medicare Tax?

The Federal Insurance Contributions Act (FICA) requires all U.S. employers and employees to pay income tax into its social insurance programs. FICA is divided into two parts. The Old Age, Survivors and Disability Insurance (OASDI) tax funds Social Security. The Hospital Insurance (HI) tax funds Medicare Part A — and, as such, is more commonly known as the Medicare Tax.

As of 2018, the Medicare Tax for U.S. employers is 1.45%. Employees pay 1.45% on their first $200,000 in wages ($250,000 for joint returns; $125,000 for married taxpayers filing separately) and 2.35% on all wages over $200,000. That extra 0.9% paid out by high earners is known as the Additional Medicare Tax. It was implemented as part of Obamacare.

Self-employed Americans are responsible for paying the full 2.9% Medicare Tax on their earnings.

How is Medicare Part A funded?

Medicare Part A (hospital insurance) is paid through the Hospital Insurance (HI) Trust Fund held by the U.S. Treasury. The fund primarily comprises revenue from Medicare Tax. It is also maintained through taxes on Social Security benefits, premiums paid by Medicare Part A beneficiaries who not yet eligible for other federal retirement benefits, and interest on its investments

Learn more about Medicare Part A.

How is Medicare Part B funded?

Medicare Part B (outpatient insurance) is paid through the Supplementary Medical Insurance (SMI) Trust Fund held by the U.S. Treasury. The fund is primarily comprised of premiums paid by Medicare Part B and Part D beneficiaries, general federal and state revenue, and interest on its investments.

Learn more about Medicare Part B.

How is Medicare Part C funded?

Medicare Part C, also known as Medicare Advantage, is a private alternative to Medicare Part A and Part B. Medicare Part C is funded by separately by the premiums enrollees pay for their Medicare Advantage health care plan.

Learn more about Medicare Part C.

How is Medicare Part D funded?

Medicare Part D (prescription drug coverage) is funded through the SMI Trust Fund and the premiums paid by Medicare D beneficiaries.

Learn more about Medicare Part D.

The future of Medicare funding

Medicare currently covers around 58.4 million people, per the 2018 Medicare Trustees Report. But the number of beneficiaries is outpacing the number of people paying into the system, creating a funding gap. Lower wages (i.e. lower payroll taxes) in recent years have exacerbated the problem. Total Medicare expenditures in 2017 reached $710.2 billion, while total Medicare income was $705.1 billion. Based on the current projections of the Centers for Medicare and Medicaid, an office of the Department of Health, the HI Trust Fund will run out of funds in 2026.

That doesn’t mean Medicare will go away in eight years. The shortage applies to the HI Trust Fund, which pays for Medicare Part A. The SMI trust fund, which pays for Medicare Part B and Medicare Part D, remains solvent, given that the majority of their beneficiaries pay premiums to participate in the program. (Conversely, Medicare Part A is premium-free for most enrollees.)

Congress can act to address the HI shortfall. For instance, they could raise the Medicare Tax or the age for which Americans are eligible for benefits. But, for now, the path forward remains unclear.

Learn more about Medicare.

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