Last week I had an interesting conversation with my client regarding our fears about pension funds and assumed rates of return. I mentioned that two of my biggest fears are this year’s seven-year bull market and the market’s correction. My client agreed with me, but I was left confused and intrigued. I wanted to know more. What are pension funds and assumed rates of return?
Most pension funds assume a rate of return to get the target value into their funds. For example, If you have an assumed rate of return of 10%, you’ll need a certain number amount to pay for all employee pensions. You’ll double the amount, however, if you assume a 5% rate of return. Most pension funds currently have 7-8% assumed rates of return.
I eagerly injected as my client is explaining the assumed rate of return. “Shouldn’t there be a 5% assumed rate of return because of the low growth mode?” My client laughed. He answered that the pension companies would never change because the very structure of the system would be dismantled.
Who would have thought that the assumed rates of return were such a realistic fear? This is scary.
What The Experts Are Saying
Global chief economist for Vanguard Group, Joe Davis adds, “Global growth has been frustratingly fragile. In the last three years, it has been significantly lower than the cycle a decade ago, and there is little acceleration in any economy of the world right now.”
Therefore, assumed rates of return should be closer to 6% or lower. As a result, the state would have to come up with the money to fund the deficit created within the pensions promised to employees. For example, Hawaii just lowered the assumed rate of return from 7.75% to 7.50%. The 60% funded ratio was ranked the ninth worst in the country (2013 statistics). Only two states, South Dakota and Wisconsin were 100% fully funded. Illinois (39%) and Kentucky (44%) were the worst. For more information visit this link.
You can learn even more here.
The Inverse Relationship Between Rate of Return and Your Pension Fund
It is imperative to understand the inverse relationship between the rate of return and pension fund money.
If you lower the rate of return, you will consequently need more money pushed into the pension fund because the capital demand must be met in the future. This is based on the assumed rate of return. So where will states get these funds? The public sector, the taxpayer.
What can be done in the public sector to help this situation?
What if Marijuana Was Legalized?
Did you know that the tax rates for marijuana are 25-40%? Think about it in terms of generating funds from taxpayers.
I would argue that the state pension fund shortage could be offset by the legalization of marijuana. Visit this link for more information.
Medical Marijuana Is A Valuable Asset in Legalized States
I never knew how much money there was in medical marijuana until I had a phone call with a Medical Marijuana Dispensary owner. I was blown away. If you haven’t seen it, please check out the CNBC program that highlights the medical marijuana dispensaries and their business model. Learn more here about the effects of marijuana on tax income growth.
Marijuana tax rates generated by its legalization can effectively mitigate this frightening circumstance, especially after contemplating the fears of the assumed rate of return.
Legalizing marijuana would allow its consumers to pick up the tax burden, which would enable states to conservatively decrease their assumed rates of return. Makes sense.