What Is an Underfunded Pension Plan?

An underfunded pension plan is a company-sponsored retirement plan that has more liabilities than assets. In other words, the money needed to cover current and future retirements is not readily available. This means there is no assurance that future retirees will receive the pensions they were promised or that current retirees will continue to get their previously established distribution amount. An underfunded pension may be contrasted with a 澳洲幸运5官方开奖结果体彩网:fully-funded or 澳洲幸运5官方开奖结果体彩网:overfunded pension.

Understanding an Underfunded Pension Plan

A defined-benefit pension plan comes with a guarantee that the promised payments will be received during the employee's retirement years. The company invests its 澳洲幸运5官方开奖结果体彩网:pension fund in various assets in order to generate enough income to service the liabilities posed by tho💛se guarantees for both current and future retirees.

The 澳洲幸运5官方开奖结果体彩网:funded status of a pension plan describes how its assets versus its liabilities stack up. "Underfunded" means that the liabilities, or the obligations to pay pensions, exceed the assets that have accumulated to fund those paymentꦕs.

Pensions can be under🌄funded for a number of reasons. Interest rate changes and stock market losses can greatly reduce the fund's assets. During an economic slowdown, pension plans are susceptible to becoming underfunded.

Funding a Pension

Under current IRS and accounting rules, pensions can be funded through cash contributions and by company stock, but the amount of stock that can be contributed is limited to a percentage of the total portfolio. No more than 5% of pension assets can be in any one company's stock.

Companies generally contribute as much stock as they can in order to minimize their cash contributions; however, this practice is not sound portfolio management because it results in an overinvestment in the employer's stock. The fund becomes overly dependent on the 澳洲幸运5官方开奖结果体彩网:financial health of the employer. Evꦡen with the 5% limit, such an amount in one company can make its success have a significant impact on the pension's success.

A plan is considered at risk for a plan year if the "funding target attainment percentage for the preceding plan year is less than 80% and for the preceding year is 70%.

The need to make this cash payment could materially reduce the company's earnings per share, a✅nd therefore its stock price. The reduction in company equit🦹y could even trigger defaults on corporate loan agreements. This has serious consequences ranging from higher interest rate requirements to bankruptcy.

Determining If a Pension Plan Is Underfunded

Figuring out whether a company has an underfunded pension plan can be as simple as comparing the fair value of plan assets to the accumulated benefit obligation, which includes the current and future amounts owed to retirees. If the fair value of the plan assets is less than the benefit obligation, there is a 澳洲幸运5官方开奖结果体彩网:pension shortfall.

The company is required to disclose this information in a footnote in the company's 10-K annual financial statement. 

There is a risk that companies will use overly-optimistic assumptions in estimating their future obligations. Assumptions are necessary when estimating long-term obligations. A company may revise its a𒐪ssumptions as time goes on to minimize a shortfall and avoid the need to🐟 contribute additional money to the fund.

For example, a company could assume a long-term rate of return of 13%, which would increase the funds expected to come from investments and reduce the need for a cash infusion. In real life, the long-term return on stocks is about 10% and the return on bonds is even lower, making the portfolio's overall return less than 10%.

Underfunded vs. Overfunded Pensions

The opposite of an underfunded pensionไ is, of♍ course, an overfunded pension. A fund that has more assets than liabilities is overfunded.

Actuaries calculate the amount of contributions a company must pay into a pension based on the benefits participants receive or are promised and the estimated growth of the plan’s investments. These contributions are tax-deductible to the employer.

How much money the plan ends up with at the end of the year depends o🏅n the amount they paid out to participants 𓆉and the investment growth they earned on the money. As such, shifts in the market can cause a fund to be either underfunded or overfunded.

It is common for 澳洲幸运5官方开奖结果体彩网:defined-benefit plans to become overfunded in the hundreds of thousands or ev🐠en millions of 💝dollars. An overfunded pension plan will not result in increased participant benefits and cannot be used by the business or its owners.