In our last post we decided that we would compare the DB and DC plans at entitlement age. In order to make that comparison, we'll need to make some assumptions about the rate of return on the program investments and how long someone will generally live to collect monthly benefits.
First we'll look at the rate of return. Currently, 10-Year US Treasury is yielding about 2%. Interest rates on money market accounts seem to be around 2.25% on average. The stock markets are at all time highs! A LOSAP is generally invested in a blended portfolio, typically on the more conservative side, such as 30 to 40% equities and 60 to 70% fixed income. A survey of asset managers available online pegs the US equity market earning around 6.25% over the next 10 years. The same survey estimates US corporate bonds to return about 3.25% during that same period. Using these estimated returns, a 40/60 equity to bond ratio would result in an expected 4.5% rate of return. A 30/70 allocation would be around 4.20%, and a 50/50 ratio at 4.75%. Since 4.5% is right about in the middle for a 10-year period, we'll use a 4.5% assumed rate of future investment return.
Second, we need to make an assumption about how long someone will live to collect the monthly benefits. Typically, this is where an actuarial assumption would come into play. But in order to keep this from being too technical, it may be helpful to instead use the results of an annual study released by the Centers for Disease Control and Prevention (or CDC). The most recent study indicated that an average male at age 65 will live to age 83, or 18 years. A 60 year old is expected to live about 22 years, or to age 82. We will use these figures to perform our analysis for an "average" male.
The next step will be to make the actual projections, which we'll tackle next time.