How Well Did Your Pension Plan Do in 2005?

How well did your pension plan perform in 2005? What did you use as a benchmark? What has been your pension plan's annualized rate of return over the past several years? Are the returns meeting expectations? These are just a few of the questions you should be addressing when examining the performance of your plan. What information will you need to go about calculating your pension plan's performance?

Required Information

Let us consider the case of Dr. William Toth. Dr. Toth is a general surgeon aged 55 and plans on retiring within the next 7 to 10 years and wants to make sure that he is on track to meet his retirement goals. On January 1, 2002, his 401(k) balance was approximately $474,000. On December 31, 2005, his account balance was approximately $820,000. In addition, he had made plan contributions of $40,000 in 2002 and 2003, $44,000 in 2004, and $46,000 in 2005. Dr. Toth's pension plan has 73% more at the end of 2005 than at the end of 2002, but what has been the actual performance of the plan?

In order to determine Dr. Toth's investment results, he'll need the monthly account statements for the time periods in question, an accounting of deposits and withdrawals that includes the dates they were made, and the months in which management fees were assessed against the account. In the case of Dr. Toth, this information was gathered for the time period of January 1, 2002, through December 31, 2005—assuming all plan contributions were made on the first day of each quarter (ie, January 1, April 1, July 1, and October 1) in equal installments. Also, it is assumed that the returns are net of an asset management fee of 1.25% charged annually, assessed quarterly at the end of each quarter (0.3125% at the end of the quarter) on the ending account balance. Other than management fees, no other withdrawals have been made.

Exploring Methodology

The methodology utilized in computing the plan's return is known in financial circles as "discounted cash flow analysis." From the table, one can see that Dr. Toth's starting balance on January 1, 2002, is $474,112. If he made no deposits during 2002 and earned a 7% rate of return that year net of any and all fees, the year-end balance on December 31, 2002—assuming that there were no other fees, expenses, or withdrawals assessed against the account—would be $507,300.

In other words, $507,300 is the accumulated future value of $474,112 invested on January 1, 2002, for 1 year assuming a 7% net tax. Obviously, you would have to adjust these figures to reflect any deposits or withdrawals made to the plan during the course of the year, which of course were factored into the equation for Dr. Toth. Conceptually, this is how the problem is solved. However, in order to accomplish this task, you would require a financial calculator, or some sort of financial spreadsheet program and knowledge of discounted cash flow techniques.

Therefore, if Dr. Toth needs to accumulate funds at a rate of 8% annually throughout his investment time horizon prior to retirement, he is going to have to alter his investment strategy and change his retirement expectations. Such an exercise is going to be crucial from a long-term retirement planning perspective, because the higher the return, the faster the rate of compounding and accumulation, especially on a tax-deferred basis, and hence the greater the annual income distributions generated during your retirement years.

Thomas R. Kosky and his partner, Harris L.

Kerker, are principals of the Asset Planning,

Group, Inc, in Miami, Fla. The company specializes

in investment, retirement, and

estate planning. Mr. Kosky has also taught

corporate finance in the Saturday Executive and Health

Care Executive MBA programs at the University of Miami in

Coral Gables, Fla, for the past 22 years. Mr. Kosky welcomes

your questions or comments at 800-953-5508, or

visit www.assetplanning.net.