What Is a Funded Pension Plan?

Mary McMahon

A funded pension plan is designed to have money available to meet liabilities, primarily pension obligations to retired and retiring employees. This contrasts with unfunded plans, where employees make payments as needed and do not keep funds in reserve. There are a number of advantages to establishing and maintaining a funded plan, including the assurance that the company will have money available when people retire. Managing a plan can be complex, requiring careful actuarial calculations and investments over time.

Man climbing a rope
Man climbing a rope

Money to establish and maintain a pension plan can come from a number of sources. Employees may contribute part of their paychecks, on a percentage or set basis, and employers can also add money to the funded pension plan. This money can be invested to strategically grow the principal. More conservative investment strategies may be favored to reduce the risk of taking big losses that might decimate the plan. As the principal grows, more investment opportunities and income can be available.

Actuaries can determine how much money should be kept in the funded pension plan on the basis of a number of factors. They look at how many employees will retire each year, and their life expectancies according to current statistics. In addition, they can consider the amount of each pension payment. These may be fixed, based on a percentage of income earned at retirement, or based on other metrics, and can be adjusted for inflation. It is impossible to predict precisely how much money will be needed, but estimates can provide guidance.

Evaluation may determine that the plan is underfunded. It may not have enough money to cover its employees or could be at risk of running out. When this occurs, the funded pension plan may need to be reorganized to increase operating efficiency and provide access to better investments. Employers may also be obliged to deposit a bulk sum to top off the principal and keep investments earning enough to support personnel.

Companies may be barred from borrowing from or against a funded pension plan. This is designed to protect the money set aside for retirement purposes, to ensure it will be available for employees in the future. In cases where borrowing is permitted, it may be necessary to provide a proposal with information about how the debt will be repaid. This typically includes a schedule for repayment, to assure employees and regulators that money will be made available when people are ready to retire.

Discuss this Article

Post your comments
Forgot password?