Return on plan assets

Definition

Return on plan assets is a financial metric used to evaluate the performance of a pension plan's investments, representing the earnings generated from the plan's assets over a specific period. This measure helps assess how effectively the assets are being managed and can influence the funding status of the pension obligations. A higher return indicates better investment performance, which can reduce the overall liabilities of the plan.

5 Must Know Facts For Your Next Test

1. The return on plan assets is typically expressed as a percentage, calculated by dividing the investment income generated by the plan's assets by the average value of those assets during the period.
2. Investment income can come from various sources, including interest, dividends, and capital gains on stocks and bonds held within the pension plan.
3. Actuaries often use expected return on plan assets as an assumption in calculating pension expenses, impacting how companies report their financial statements.
4. A lower than expected return on plan assets may lead to increased pension expense and potential funding challenges for companies to meet their future obligations.
5. Returns on plan assets are closely monitored because they play a crucial role in determining the overall health and sustainability of a pension plan.

Review Questions

• How does return on plan assets affect the overall financial health of a pension plan?
  • Return on plan assets directly influences the financial health of a pension plan by affecting both its funding status and pension expense calculations. A higher return reduces the need for additional contributions from the sponsoring employer, improving liquidity and stability. Conversely, a lower return can lead to increased liabilities and potentially require higher contributions to meet future obligations, impacting overall financial performance.
• Evaluate how assumptions about return on plan assets can impact reported pension expenses and financial statements.
  • Assumptions about return on plan assets significantly impact reported pension expenses because these assumptions are used in actuarial calculations for pension liabilities. If companies expect higher returns, they may report lower expenses, which can improve their net income figures. However, if actual returns fall short of expectations, it may result in increased future expenses and adjustments to financial statements, potentially leading to volatility in reported earnings and equity.
• Analyze the implications of consistently low returns on plan assets for long-term corporate strategies regarding employee benefits.
  • Consistently low returns on plan assets can compel companies to reevaluate their long-term strategies regarding employee benefits. Companies may face pressure to increase contributions or adjust their investment strategies to achieve better returns. This situation could lead to potential restructuring of pension plans, moving towards defined contribution plans instead of traditional defined benefit plans, which shift investment risk away from employers. Additionally, it could impact employee retention and recruitment if benefits become less competitive in response to funding challenges.

Related terms

Pension Expense: The total cost recognized in a period for providing pensions to employees, including service costs, interest on the liability, and expected return on plan assets.

Service Cost: The present value of benefits earned by employees for their service in the current period, representing the cost of future pension benefits.

Funding Status: The difference between the fair value of plan assets and the projected benefit obligation, indicating whether a pension plan is overfunded or underfunded.