Expected return on plan assets

Definition

The expected return on plan assets refers to the anticipated rate of return that a pension plan's investments will generate over a specified period. This concept is crucial for pension plans as it helps in determining the funding requirements and assessing the overall financial health of the plan, influencing contributions made by employers and the benefits paid to retirees.

5 Must Know Facts For Your Next Test

1. The expected return on plan assets is typically calculated using historical rates of return and considering the asset allocation of the pension fund.
2. This return is used in accounting practices to help recognize the cost of pension benefits and affects the income statement of companies offering defined benefit plans.
3. Higher expected returns can reduce the required contributions from employers, but they also carry more risk if actual returns fall short.
4. Investment strategies that rely on equities might have a higher expected return compared to those focused on bonds or cash equivalents.
5. Changes in economic conditions, market performance, and interest rates can significantly impact the actual returns on plan assets.

Review Questions

• How does the expected return on plan assets influence employer contributions to pension plans?
  • The expected return on plan assets plays a critical role in determining how much employers need to contribute to pension plans. If a higher return is anticipated, employers may be able to contribute less because the investment earnings are expected to cover more of the future benefit obligations. Conversely, if returns are projected to be lower, employers will likely need to increase their contributions to ensure that there are sufficient funds to meet retirement benefit payments.
• Discuss the relationship between expected returns on plan assets and the overall funding status of a pension plan.
  • The expected returns on plan assets directly impact a pension plan's funded status. A higher expected return can improve the funded status by projecting greater asset growth, which helps cover future liabilities. However, if actual returns fall short of expectations, it can lead to an underfunded status, increasing liabilities and potentially necessitating additional employer contributions to meet obligations.
• Evaluate how changes in economic conditions might affect both the expected return on plan assets and the actuarial assumptions underlying a pension plan's financial projections.
  • Economic conditions such as fluctuations in interest rates, inflation, and market volatility can significantly alter both the expected return on plan assets and the actuarial assumptions for a pension plan. For instance, if interest rates rise, fixed-income investments may yield higher returns, potentially increasing the expected return on assets. However, if market volatility increases and investor confidence decreases, projected returns might be lowered. Additionally, these economic shifts can cause actuaries to reassess mortality rates and salary growth assumptions, impacting overall financial projections and funding strategies for the pension plan.

Related terms

Pension Liability: The obligation of a company to pay retirement benefits to employees, which is calculated based on the present value of future benefit payments.

Funded Status: The financial condition of a pension plan, determined by comparing the plan's assets to its liabilities; it indicates whether a plan is fully funded, underfunded, or overfunded.

Actuarial Assumptions: Estimates made by actuaries regarding key factors like mortality rates, salary increases, and investment returns that affect the financial projections of pension plans.