How Rates of Return Affect Pension Contribution Rates

In the post “How Rates of Return Affect Required Pension Assets,” the point is made that depending on the rate of return achievable by the pension fund, there are significant changes to what level of assets are required for that fund to remain solvent. This post takes a slightly different approach; looking at an individual pension participant, how do pension fund rates of return affect how much they will have to contribute into their pension each year?

To make this estimate, the same set of assumptions are used in this post as in the previous post; they are:

The participant works for 30 years and they are retired for 30 years. The participant earns a pension equivalent to 66% of their final salary. The participant’s salary, in real (inflation adjusted) dollars, doubles at an even rate between the time they begin working and when they retire. The rate of return and the rate of inflation are held constant throughout the 60 year period under analysis. The rate of inflation is assumed to be 3.0% per year (this is CalPERS official projection, and is consistent with the historical average for the last 90+ years).

Here’s what we get:

There are a lot of takeaways here, but the most important is this: Even at a return of 7.5% per year, which is actually slightly below CalPERS official long-term projected annual return of 7.75% per year, using these assumptions there [...] Read More