What does the internal rate of return allow sponsors to determine?

The internal rate of return (IRR) is a key financial metric that helps sponsors assess the profitability of an investment by determining the discount rate at which the net present value (NPV) of all cash flows equals zero. In the context of retirement plans and investment strategies, IRR is particularly valuable for evaluating whether the returns on investments are aligned with the assumed rate of return used in actuarial calculations.

When sponsors examine the IRR, they can compare it to the expected or assumed rate of return to ensure that their investment strategy is on track to meet future obligations, such as pension payouts. If the IRR meets or exceeds the assumed rate of return, it indicates that the investments are performing well and are likely sufficient to support the plan's liabilities. If the IRR falls short, it may prompt a reassessment of the investment strategy or asset allocation.

Understanding the IRR provides insight into the effectiveness of the investment approach and aids in long-term financial planning for retirement benefits. This focus is critical as it directly influences the adequacy of the funding of the retirement plan and its ability to meet participant needs in the future.