The governments generally assume that pension funds will earn 8 percent a year. That’s roughly the historical return of the stock market. Using that assumption, the Center for Retirement Research at Boston College estimates a current funding gap of $700 billion for all state and local governments.
There are two reasons to question the 8 percent number, however. My own instinct is that one of the reasons is more valid than the other. The first — the one for which I have not yet heard a persuasive argument — is that the stock market does not return 8 percent a year over every given period.
The second reason to question the 8 percent assumption strikes me as more valid and more worrisome. Should we really assume that the stock market will return 8 percent in the future, as it has in the past? I’m not so sure.
If state and local governments instead assumed a future return of 7 percent, their funding gap would nearly double, to $1.3 trillion, according to Alicia Munnell and her colleagues at the Boston College retirement center. If they assumed a 6 percent return, the funding gap grows to $1.8 trillion.
