New assumed rate of return will have a big impact for ERS Retirement Trust Fund
September 6, 2017
At its August 23 meeting, the Employees Retirement System of Texas (ERS) Board of Trustees voted to adjust the assumed rate of return on investment of the ERS Retirement Trust Fund to 7.5%, down from 8%.
The assumed rate of return is what ERS expects its investments to earn each year, on average. ERS uses the rate of return to assess the long-term health of the retirement trust and determine if it will be able to meet its obligations to current and future retirees.
The new assumed 7.5% rate of return provides a more realistic forecast of current and future financial conditions, allowing the Texas Legislature to make better-informed decisions about future funding.
How does this decision affect active employees and retirees?
One outcome of ERS’ decision is that the retirement trust will not be actuarially sound any time soon. After contribution increases by both the state and employees in 2015, the fund was on the path to actuarial soundness. But the new assumed rate of return has changed that. (For the Trust Fund to be actuarially sound, it must be sufficiently funded to pay obligations for the next 31 years.)
The decision could affect active employees because the Texas Legislature could ask them to chip in more from their paychecks each month at some point in the future. It’s important to keep in mind, however, that Texas law says employees cannot pay a higher monthly contribution than the state. And by law, the state can’t put in more than 10% of payroll. Currently, the state and employees both contribute 9.5% of salary, and each state agency contributes 0.5% of its payroll to the ERS Retirement Trust Fund.
Lowering the rate of return affects retirees because they cannot get an annuity increase, such as a cost–of-living adjustment (COLA) or “13th check,” unless the Fund is actuarially sound and would stay actuarially sound after the increase. The Fund wasn’t actuarially sound before the rate change, and it’s even further away from actuarial soundness now.
Why did the Board make the change, if it negatively affects the Fund?
The new assumed rate of return takes into account actual inflation rates and other financial information. It is based on a more realistic expectation of future earnings in today’s investment climate and provides a more accurate picture of the Fund’s long-term financial status.
This will be important in the future as lawmakers decide how much state funding will be needed to meet retirement commitments to current and future employees. The Board did not make the decision lightly, but they knew it was necessary. As Trustee Cydney Donnell said, “You can’t continue on the trend that we’ve been going on forever. Most people … are not going to see their daily lives impacted too much over the next few years. It’s in the longer term that it becomes critical.”
Board Chair Craig Hester added, “This Fund has been a tremendous asset to the state employees – hopefully for retention, as well as recruitment. It’s something that needs to be addressed, and we all need to work together to get it right.”
Can ERS improve the Trust Fund through investment earnings?
The ERS Investments team works to ensure strong returns on our investments. In fact, about two-thirds of retirees’ annuity payments come from investment earnings. But investment earnings alone—even very good ones—are not enough to make the Trust Fund healthy again.
Why isn’t the Retirement Trust Fund actuarially sound?
The ERS retirement plan is a defined benefit plan. That means eligible retirees earn stable annuity payments from the time they retire throughout the rest of their lives.
For a defined benefit plan to work, the contributions to the Fund plus investment earnings must equal the benefits paid plus any operating expenses. For about 20 years, starting in the early 2000s, contributions were not enough to meet long-term financial commitments to retirees and active employees. In addition, two major economic downturns and changes in the state workforce have affected the Fund’s balance.
When properly funded, defined benefit plans are a cost-effective way to deliver retirement benefits. In fact, compared to a defined contribution plan, such as a 401(k), a defined benefit plan delivers at least the same benefit at half the cost. But the ERS plan was not properly funded for many years.
The Fund is not in immediate danger and currently is able to meet its commitments for the next few decades. There is time to make reasonable changes to keep it healthy.