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What is an Underfunded Pension Plan?

Tricia Christensen
By
Updated May 17, 2024
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For many decades, workers have relied on the security that they would retire with a reasonable pension, and that amount, usually paid on a monthly basis, was not subject to change. Companies made certain that money would exist to pay pensions, by fully funding their pension plans. A fully funded pension plan is one where the company has 100% of the money needed to cover current pensions and those that will be paid out in the future.

As the economy took a downturn in the late 1990s, many companies sought to provide more spendable cash by creating an underfunded pension plan, where the money to cover all pensions owed currently, or in the future was not available. Essentially the liabilities of the underfunded pension plan exceeded its assets, changing the profile of the retiree significantly. For many people, this results in no surety that they will get the pension they were promised or for those who are retired, it may cause a significant drop in current pension distribution amounts.

There are several reasons why an underfunded pension plan may exist or why one may become underfunded. Many pension plans invest in stock, and if stock investments result in huge losses, this can mean a plan becomes underfunded. Pensions that are in savings accounts have suffered from low interest rates, which mean they are not accumulating the interest they need to be fully funded. Alternately, mergers might create an underfunded pension plan, and bankruptcy can completely eliminate a plan. Current US laws favor paying debtors before employees who are due a pension. The burden of paying retirement benefits then falls to the American taxpayer in the form of Social Security payments, which itself is underfunded and set to expire if laws are not changed. The US doesn’t presently collect enough to keep Social Security fully funded.

There have been some extreme examples of the way an underfunded pension plan can dramatically affect the retirement income of certain workers. In 2005, a federal court allowed United Airlines to default on its underfunded pension plan. Retirement pay for workers, especially pilots, dropped sharply. Some were receiving as much as $12,000 US Dollars (USD) per month and saw this amount drop to $2000 USD. In other companies, pensions drop by a few hundred dollars a month, but this can still dramatically affect ability to live well or survive if pension income is small.

It’s estimated that only about 30-40% of pension plans are now fully funded, which means that people should take action by preparing for retirement without including what they may get in future pensions. Some companies have already taken this step by allowing people access to 401k investments, and using matching funds. They essentially privatize the pension system, and if workers make sound investments, they may have significant funds to cover retirement. Individuals may also set up their own retirement plans through IRAs and the like to help cover drops in income or possible defaults on pension.

People who have not gotten ahead with savings or acquirement of assets, and who face sharp cuts in their pension now realize they may need to continue working long after they planned to retire. For many young people, the idea of working for the rest of your life is pretty much standard, especially with Social Security possibly not available in the future and no guarantee of pension payouts.

WiseGeek is dedicated to providing accurate and trustworthy information. We carefully select reputable sources and employ a rigorous fact-checking process to maintain the highest standards. To learn more about our commitment to accuracy, read our editorial process.
Tricia Christensen
By Tricia Christensen , Writer
With a Literature degree from Sonoma State University and years of experience as a WiseGeek contributor, Tricia Christensen is based in Northern California and brings a wealth of knowledge and passion to her writing. Her wide-ranging interests include reading, writing, medicine, art, film, history, politics, ethics, and religion, all of which she incorporates into her informative articles. Tricia is currently working on her first novel.

Discussion Comments

By anon950158 — On May 08, 2014

Everybody in the pension plan should take cuts. Workers have been paying the freight, unfunded 61 percent, 1 percent multiplier, retirees with power collecting pensions and still working. Forty-somethings have paid more into these funds than the people the government protects. Make it even for all in the plans or they will dissolve. Pay Social Security on every penny like most people in these plans. Simple.

By Bhutan — On Jan 27, 2011

Brickback- A friend of mine has a cash balance pension plan. Her company contributes to the plan for her and at retirement she would receive a lump sum or an annuity over the term of her life.

The advantage to this plan was that she could see how much money the plan contained because employers were required to supply this information to covered employees.

Most of these plans are calculated on a benefit schedule that determines how much money you will receive based on the years that you’ve worked for the company.

By BrickBack — On Jan 26, 2011

Cafe41- That is so true. I just wanted to say that my mother-in-law had a defined benefit plan as a self employed business owner.

She used One Person Plus as her defined benefits plan. She had to set a target amount that she wanted to have yearly when she retired and then whatever she put into the fund was measured to offer this benefit.

The payments into the fund were based on the three highest earning years, her retirement age, and her present age. She has to continue to make contributions every year because it is mandatory.

By cafe41 — On Jan 23, 2011

Latte31- I agree with you. We really can no longer rely on pension plans because so many of our companies are becoming insolvent.

Even state and local governments have to also supply payments on these hefty defined pension plans and have trouble funding these pensions.

Many municipalities are so underfunded that it puts many of these pensions in jeopardy. The pension actuary should have made better forecasts with respect to the financial risks that many of these municipalities currently face.

By latte31 — On Jan 21, 2011

Anon77210- It may seem that way but an employee pension plan is a benefit offered to the employee at retirement for continued service. The employee simply has to continue working at the company to be offered the benefit.

They do not put any of their own money into the plan, so this is why I do not think that they are a pyramid scheme.

Remember a retirement pension plan was developed in the 1950’s as a way to retain employees over the long haul. This reduced employee turnover and ensured a qualified workforce for years to come.

The problem now involves the enormous costs associated with these plans. In the 1950’s General Motors was the market leader in the world with respect to automobile manufacturing which is a far cry from where they are now.

They currently face $5 billion in pension payments alone which puts GM at a huge disadvantage with competitors like Nissan who do not have to bear these costs.

By anon77210 — On Apr 13, 2010

thirty and out, and payment schemes of the same nature don't help and make some pensions no more than a pyramid scheme.

Tricia Christensen

Tricia Christensen

Writer

With a Literature degree from Sonoma State University and years of experience as a WiseGeek contributor, Tricia...
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