A guaranteed return plan builds retirement income for participants by creating notionally personal accounts for each employee, and blending investments to be managed by a retirement system. The retirement system invests the money for members and guarantees that they’ll earn at least a certain return, usually with a share of returns above that minimum amount. Upon retirement, the accumulated balance for each employee is converted into guaranteed income. Or if an employee leaves for another job, they can take the entire vested balance of their account with them.
In a guaranteed return plan (GR), you and your employer both make contributions to a fund managed on your behalf. The retirement system invests the money for you and guarantees that you’ll earn at least a certain amount on your investment. During your working years, you accumulate contributions and the minimum investment return on those contributions, plus some share of investment returns above that minimum. When you reach retirement, you can choose to convert the accumulated savings into income that is guaranteed for life—which essentially turns your guaranteed return plan into a traditional pension.
Guaranteed return plans are sometimes called “money purchase” or “cash balance” plans. Technically, they are “defined benefit” plans like traditional pensions—the benefit being “defined” is the guaranteed rate of return rather than a fixed amount of income.
Just like guaranteed income plans (traditional pensions), the retirement system in a guaranteed return plan holds all of the money and manages the investments. The people running the system keep track of exactly how much has been contributed in your name, and then track how much of the overall investment return the fund earns should be added to those contributions at regular intervals. So, while individual teachers don’t have to make any decisions about their investment strategy, they also don’t have any control over that strategy.
A typical guaranteed return plan promises a minimum of around 4% on accumulated retirement savings (i.e., contributions from you and your employer). Usually, any investment returns above the minimum amount are shared between employers and employees—some of the additional investments would be added to your account, and the remainder would go to a reserve fund for the system to use in case it needs funds to provide the minimum investment guarantee down the road if investments underperform.
Guaranteed return plans usually provide some options for how you want to use your savings when you retire. All guaranteed return plans will give you the option to take your money as a lump sum. You can also convert this savings, or any part of it, into a monthly check you receive over the course of your retirement—a process known formally as “annuitizing.” Some guaranteed return systems will administer this themselves, so you’d get a pension check just like if you were in a guaranteed income plan. Others use a third-party provider to distribute the annuity.
A Typical Example:
- Employees and employers each contribute 5-7.5% of pay (for a total of 10% to 15%).
- The state guarantees (through the retirement system) a 4% annualized return will be credited to the employee account.
- The GR plan also provides share of upside returns:
- 3/4ths (75%) of any investment returns above 4% are also credited to the employee account.
- 1/4th (25%) of investment returns above 4% are reserved to the state retirement fund (to cover management costs and create a pool of funds for years where investment returns are low).
- Employees vest in their employer contributions over a period of two to five years.
- Employees can leave at any time, and take with them the full balance of their account — including investment returns and vested employer contributions, along with their own contributions.
- Upon applying for retirement, employees can have the accumulated total of their account converted into guaranteed monthly income (just like a traditional pension).
The Pros and Cons:
There are various ways that retirement benefits can be offered. Each can be measured against different kinds of objectives. Here is how GR plans compare to other retirement plans on a few common goals that states and local employers have for offering retirement benefits in the first place.