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Myth: The Assumed Rate of Return Determines the Value of Your Benefits

Fact: The value of your benefits is determined using a formula completely separate from the assumed rate of return.

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.

 

Case Study:

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, they didn’t change it. When they lost money in the Enron scandal, they didn’t change it. Even after the financial crisis of 2008–2009, they didn’t change it.

Over that period, TRS earned strong investment returns. In fact, from 2001 to 2018, there were nine times when annual investment returns were larger than 8%.

Unfortunately, the years where investment returns were lower added up. The average investment return for TRS between the time when the pension was last fully funded (2001) and today was around 6%—less than the 8% predicted. Even worse, financial advisors now believe that the odds of TRS earning an 8% return in the future are just 1 out of 5. TRS recently lowered its assumed return to 7.25%, trying to be more conservative in its future outlook.

They might lower it again in the future. While TRS’s unfunded liabilities rose due to this imbalance, the change in the assumed return did not change the benefits for retired or active teachers. They will still get the same pension benefits promised to them; TRS will have to figure out a way to make up the difference.

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