Expected return on plan assets

Definition

The expected return on plan assets refers to the anticipated income generated from the investments made by a pension plan to fund its future obligations. This expectation is crucial as it helps determine the overall financial health of the pension plan, impacting the calculations for pension expenses and obligations. By estimating returns, organizations can better manage their funding strategies and ensure they have sufficient resources to meet their retirement commitments.

5 Must Know Facts For Your Next Test

1. The expected return on plan assets is typically based on historical performance and reflects the long-term investment strategy of the pension plan.
2. It is used in the calculation of pension expense, specifically reducing the overall expense recognized in financial statements.
3. The assumption of expected return can influence funding decisions, affecting how much an organization needs to contribute to meet its future pension obligations.
4. An increase or decrease in expected returns can lead to significant fluctuations in the funded status of a pension plan, impacting the overall financial statements.
5. The expected return is usually set based on a diversified portfolio approach to minimize risks associated with individual asset classes.

Review Questions

• How does the expected return on plan assets impact a company's financial statements?
  • The expected return on plan assets directly influences the pension expense reported in a company's financial statements. By estimating this return, companies can reduce their reported pension expense, which affects net income and overall profitability. A higher expected return can lower pension expenses, improving financial metrics, while a lower expectation can do the opposite, thereby impacting decision-making related to funding strategies.
• Discuss how changes in market conditions might affect the expected return on plan assets and what this means for pension plans.
  • Changes in market conditions can lead to volatility in the expected return on plan assets as they are heavily reliant on market performance of investments such as stocks and bonds. If market returns decline due to economic downturns or poor investment performance, it may necessitate that pension plans adjust their expected returns downwards. This adjustment could result in higher reported pension expenses and may require increased contributions from employers to ensure future obligations are met.
• Evaluate how an organization might strategically adjust its investment portfolio based on fluctuations in expected returns on plan assets.
  • Organizations may strategically modify their investment portfolios in response to changes in expected returns by reallocating assets toward more stable or higher-yielding investments. For instance, if expected returns decrease due to economic forecasts, an organization might increase its allocation to fixed-income securities or alternative investments that offer more predictable returns. Additionally, they could reconsider their risk tolerance and investment horizon, balancing short-term liquidity needs against long-term growth objectives to safeguard their ability to meet pension obligations.

Related terms

Pension Obligation: The total amount a company is obligated to pay to its employees after retirement, based on the terms of the pension plan.

Plan Assets: The investments held by a pension plan, including stocks, bonds, and other financial instruments, intended to provide benefits to retirees.

Pension Expense: The total cost recognized in a company's income statement related to its pension obligations for a given period, including service cost, interest cost, and expected return on plan assets.