How Rates of Return Affect Required Pension Assets

While pension finance is a relatively obscure discipline that requires of its practitioners expertise both in investments and actuarial calculations, it is a mistake to think the fundamentals are beyond the average policymaker or journalist. One policy question of extreme importance to discussions about the future of public worker pensions is how much pension funds can legitimately expect to earn over the long term. The reason this question is critical is because the more the pension fund earns, the lower the annual contribution will have to be. Just how much lower each percentage point gain offers is startling.

In the first table (below), conservative assumptions are offered towards estimating how much the pension funds of California’s state and local workers must earn each year. The number of active state and local government workers is fairly well documented at 1.85 million (including K-12 and higher education). The $68,000 per year annual salary is actually low, since that is the average salary, and pension fund calculations are based on the higher final salary. This means the $68,000 figure is accurate for estimating the money flowing into the pension system, but will understate the amount of money flowing out of the pension system to retirees. Similarly, the 33% average pension fund contribution is on the high side – typically only public safety employees, who are only about 15% of the state and local government workforce, contribute amounts over 30% of their salary into the pension funds. But based on these numbers, each year […] Read More