Big Pensions Eye Lower Return Forecasts. Should You?

The folks running some of the nation's largest public pension plans are contemplating the need to lower the assumed investment returns for their pension funds. If you're still holding onto great expectations for your IRA and 401(k), it's likely you too should be eyeing lower return forecasts for your retirement funds.

California Reeling
It's no secret that public pensions across the country are seriously underfunded. What might not be so widely known is that many funds use an assumed rate of return of 8 percent. And based on what's happening in California, that may be too optimistic.

  • The $201.5 billion California Public Employees' Retirement System (CalPERS) the nation's largest public pension uses a 7.75 percent assumed rate of return for its fund; a target it has managed to meet for the past 20 years. But a bevy of CalPERS consultants recently came in with an average expected return over the next 10 years of 7.29 percent. CalPERS is currently reviewing the data before making a decision on whether to lower its assumed investment rate of return.
  • The $138 billion California State Teacher's Retirement System (CalSTRs) the nation's second biggest public pension heard from its cabal of managers and consultants that its 8 percent assumed rate of return should be lowered to 7.5 percent. CalSTERs tabled the recommendation for a lower assumed investment return until the fall (after Election day) effectively pushing off any move that would boost the plan's required publicly funded contributions.
  • The San Diego County Employees Retirement Association (SDCERA) last month formally lowered the implied rate of return on its pension. But its consultants seem to be a bit more optimistic than the folks advising CalPERs and CalSTERs. The San Diego pension fund merely lowered its assumption from 8.25 percent to 8 percent. That 8 percent is more than 70 basis points higher than the average return the CalPERs consultants came up with for that plan. That's no small difference. To put it in personal terms, a $250,000 IRA that grows at 8 percent for 10 years (assuming no new investments) will reach about $540,000 At 7.29 percent it grows to $505,000 percent.
As anyone who has spent 30 seconds playing around with a retirement calculator knows full well, when your assumed rate of return is lower, the only way to reach your goal is to make some serious adjustments. You can save more (in the case of public pensions this means getting higher contributions from participants and taxpayers), invest in higher-risk assets in the hope of garnering better returns, or change the benefit formula.

As fellow MoneyWatch blogger Charlie Farrell points out, public pensions-and not just in California-have ominously gravitated toward riskier investments to juice returns. In addition to using leverage, pensions invest in all sorts of alternative investments, from real estate (a costly bet for CalPERs in recent years), currency, private equity, and even viatical settlements. Yep, seems that some Pennsylvania pensions have recently taken stakes in life settlement funds.
Adjusting your Retirement Portfolio Assumptions While there's no guarantee the varied toolbox for pensions guarantees higher returns, nor should we assume that any of us can do better than the pensions. The news out of California is further evidence that a rethink of your retirement assumptions is in order if you're still holding onto the notion that your portfolio will somehow generate returns of 8 percent or more.

Consider that Jack Bogle recently told Morningstar he thinks stocks, on average, might generate an annualized return of 7 percent or so going forward. For bonds he's not eyeing more than 5 percent. Depending on your particular asset allocation your overall return would likley be somewhere south of 6 percent. Plug that into your retirement calculator of choice and see how that changes your outcome. Making small adjustments today in your plan -investing more, or considering delaying retirement a few years-can go a long way toward heading off any shortfall.