*Originally posted on 9/28/2015
After the stock shock of 2008 and after nearly a decade of decreasing interest rates, many pension fund managers are abandoning their long-held belief that a diversified portfolio of stocks, bonds and other assets will continue to earn an annual rate of return of 8%. Public pension funds use a combination of returns earned from investments along with contributions from employees and taxpayers to fund current and future benefits, so the rate of return for a pension fund is hugely important.
According to Association of State Retirement Administrators, more than two-thirds of state retirement systems have trimmed their investment return assumptions since 2008 as the financial crisis has pushed cumulative returns below long-term expectations. The average investment return target that pension managers are aiming for stands at 7.68%, which is the lowest since the 1980s; 8.01% was the peak in 2001.
The effect of lowering forecasts for investment returns means employees and taxpayers may be asked to pay more into the pension system. Cutting back on public expenditures is also a realistic alternative as a lot of cities struggle to collect tax revenue from families whose income has stagnated or fallen. Increasing property taxes and cutting local services might work for a while, but only time will tell how long taxpayers decide to stick around when taxes in neighboring states might be a lot less. For example, the ongoing exodus of Illinois residents to Wisconsin and Indiana is virtually guaranteed as property taxes and other fees and fines continue to strain the citizens to make up for politicians’ mishandling of public pension funds.
Moving expectations below 8% also has some potentially devastating consequences because pension funds use this rate as a way to calculate the present value of future pension payments that are due to retirees. Even a small reduction in a pension’s investment return target can mean public sector employees and budget-crunched governments may be required to pay a lot more toward their pension funds to make up for current and future liabilities. A drop of just one percentage point in a pension’s investment return expectation will pump that fund’s liabilities by about 12% (Center for Retirement Research at Boston College) and these liabilities are are expected to be paid out for a longer time as Baby Boomers and subsequent generations spend more time in retirement thanks to advances in healthcare.
Even with falling expectations on investment rates, some economists argue that pensions are still leaning on unrealistic expectations to close their increasing funding gaps. Today’s assumptions are lower than what levels were in the 1960s, when pensions estimated returns of about 3% to 3.5%. Pension managers pushed their predictions higher in following decades as they took on riskier holdings of stocks, high-yield bonds, commodities, precious metals, and hedge-funds as fixed income rates have continued to fall since the early 1980s.
With a large number of public and private pension funds cutting expectations on their investment returns, it’s sure to stir up a conversation or two about something that was once thought impossible; cutting pension payments to retirees. Since that’s a long and difficult road for pension plans and lawmakers, it’s possible an easier, temporary alternative can be found. For example, the legalization and taxation of marijuana in Colorado may in part havet something to do with local municipalities’ difficulty in meeting required pension payments. Shifting more government workers to 401(k)-style accounts may also pick up more momentum and time goes by and the pension crises wears on. But whether you’re of the belief that pension payments will get trimmed or not, it’s obviously a good idea to plan for such a thing possibly happening to you down the road. After all, Social Security payments will be cut by about 25% by 2033 unless the system is overhauled just as it was in the 1980s. Given the possibility that your pension payments could get reduced, either directly or indirectly, it’s always a good idea to do things to maximize your retirement income, for example, by making use of little-known Social Security loopholes or by diversifying your assets so that they produce a healthy rate of return with little to no risk of loss.
0 Comments