Why Pensions are Underfunded

Great post by Megan McArdle.

"This table uses after inflation numbers, which makes the returns appear small. In reality, CalPERS, CalSTRS, and most other pension funds, project a long-term rate of inflation of 3.0%. This means that the nearly best case scenarios here, 7.5% before inflation (showing as 4.5% after inflation on the table), are representative of the current official long-term projections used by most pension funds. Based on the official rates of projected returns for pension fund investments, a 30 year veteran, retiring on a "3.0% at 50″ pension, will collect 90% of their salary in retirement, and they will need to contribute 32.5% of their pay into their pension fund every year they work. On that basis, 9% is less than one-third what will be necessary to fund their retirement pension. But what if the pension funds return less than 4.5% (7.5% before inflation) per year?

As can be seen, for every 1.0% the real rate of return drops, the required contribution increases by over 10%. That is, if CalPERS can only deliver a 6.5% return (3.5% after inflation), the contribution goes up from 32.5% of salary to 43.4% of salary. If CalPERS rate of return goes down to a 5.5% return (2.5% after inflation), the contribution goes up from 32.5% of salary to 57.9% of salary."