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Pension Myths & Facts: The Assumed Rate of Return Does Not Determine the Value of Benefits
You may believe that your pension benefit value calculation is based on how well your pension fund’s investments perform relative to the plan’s assumed rate of return.
However, the impact of the assumed return on benefit value is a very common myth or misunderstanding, as there is no link between investment performance and your pension benefit.
Equable Insights
- Myth: The assumed rate of return determines the value of your benefits.
- Fact: The calculation of your pension benefit value is determined using a formula completely separate from the assumed rate of return.
Does Assumed Rate of Return Impact Pension Benefits?
While pension funds do their best to predict investment returns, the assumed rate of return is just that — an assumption. It depends on external forces that pension systems can’t control, and assuming a rate of return provides no guarantee that investments will actually earn that rate. Rates of return could be, and often are, significantly higher or lower than assumptions.
The calculation of your pension benefits is determined using a formula that takes into account years of service, final average salary, and age-related qualifications to start receiving benefits. How well your pension fund’s investments perform have no bearing on the value of your benefits. (However, in some states, investment performance can impact whether or not you will receive a cost-of-living-adjustment in a given year).
Case Study: Texas TRS
The Teachers Retirement System of Texas (TRS) assumed for more than three decades that it could earn an 8% return on its investments. This was a long-term projection, so when the economy hit a recession in 2001, TRS didn’t change its assumption. When it lost money in the Enron scandal, TRS didn’t change it. Even after the financial crisis of 2008–09, TRS didn’t change it.
From 2001 to 2018, TRS earned positive investment returns on average. In fact, there were 10 times during that span when annual investment returns were larger than 8%. Unfortunately, the years in which investment returns were lower than expected began to add up.
The average investment return for TRS between the time when the pension was last fully funded (2001) and 2018 was around 6.5% — less than the 8% predicted. So, in July 2018, TRS lowered its assumed return to 7.25%, trying to be more conservative in its future outlook. Then, in July 2022, the board lowered its assumption again, from 7.25% to 7%.
This reduction in the assumed rate of return did not change the value of benefits provided for retired or active teachers. They will still get the same pension benefits promised to them because the value of benefits is not based on the assumed rate of return in any way.
This article is part of Equable’s Pension Basics series. To learn more about how your pension works, check out the other articles in the series:
1. How Pension Benefits Are Calculated
2. Vesting
3. The Pension Funding Formula
5. Normal Cost
6. Unfunded Liabilities (aka Pension Debt)
7. Actuarially Determined Contributions
11. Pension Myths & Facts: The Assumed Rate of Return Does Not Determine the Value of Benefits
12. Pension Myths & Facts: The Funded Status of Pension Plans Does Not Depend on More Public Employees
