3 truths about pensions

Key Points

  • Corporate and public pension returns have not met market expectations for growth over a 10-year period
  • Many plans are now underfunded, which could result in benefit cuts for current retirees
  • Realigning your portfolio around realistic return projections could help keep your financial plan on track

More than 4 in 10 of today’s retirees rely on pensions for part of their retirement income,1 with the average retiree distribution around $3,200 per month.² While 2017 markets were strong, longer-term trends around pension fund growth have left many retirees wondering what the future holds.

It’s a valid question: Today’s environment of modest economic growth, low interest rates and elevated equity valuations has economic experts reevaluating current assumptions around pension fund returns. 

Here’s a look at the latest numbers — and how they may impact your financial plan if you rely on a pension for part of your retirement income.

Currently, retiree benefit projections outweigh public pension fund assets. To help remedy this, many government fund administrators are in the process of adjusting return assumptions to more accurately align with current market conditions.

A closer look at long-term performance trends, which are broadly falling short of fund administrator plans, reveals part of the problem. For example, state and local government pension plans had a median return assumption of 7.5% for 2017, according to the National Association of State Retirement Plan Administrators.3 Here are the actual numbers as of year-end 2017: 

  • 10-year average annual return: 5.9%3
  • 5-year average annual return: 8.8%3
  • 1-year average investment return: 15.3%3

While shorter term return trends are improving, lower-than-expected long-term returns at year-end 2016 meant public plans were only 72% funded, resulting in a funding shortfall of $1.2 trillion.2

Shortfalls could ultimately result in pension cuts for retirees, increases in taxes or cuts in other government-funded programs to cover the pension funding imbalance.

For corporate pension plans, getting return assumptions right also has implications for a range of stakeholders, including plan participants and shareholders.

In its 2017 Corporate Pension Funding Study,consulting firm Milliman reports that the 100 largest defined benefit plans had expected returns of 7.0% in 2016. Again, here are the actual numbers as of year-end 2016: 

  • 10-year average annual return: 6.0%4
  • 5-year average annual return: 8.3%4
  • 1-year average investment return: 8.4%4

While stronger returns lately have helped with fund solvency, the longer-term trend of lower-than-expected returns means corporate plans were only 81% funded at year-end 2016, leaving a shortfall of $300 billion.3

Pension plan administrators have taken note of the changing investment environment and over time have lowered their pension return assumptions. For corporate plans, the expected return of 7.0% is down from 8.0% in 2010. For public plans, the current long-term average expected return of 7.4% is down from 7.9% in 2010.3

But are the new return assumptions still too high? Some experts would say “yes.” 

The Ameriprise Global Asset Allocation Committee is projecting average annual returns between 6.9%–8.5% for domestic equities and 2.4%–4.9% for domestic bond returns.

Here’s a snapshot of how predicted returns over the next 20 years compare with average returns over the last 30 years according to McKinsey Global Institure. These estimates closely align with the Ameriprise Global Asset Allocation Committee’s long-term outlook.

Talk to us

If a pension is a notable part of your retirement income, keep the lines of communication open with your advisor, who can adjust your overall portfolio withdrawal strategies to coincide with a changing economic environment.