Funded vs. Unfunded Pensions

By hrlineup | 17.12.2019

A pension plan is basically a fund with both assets and liabilities. It can either be funded or unfunded. If for instance the pension plan’s funds or the total number of its assets are below 90% of the existing debts then this plan is considered as unfunded.

If on the other hand the pension plan has sufficient assets, enough to provide for all the accrued benefits then this plan is categorized as fully funded. A fully funded pension plan is that which is able to make all the anticipated payments to pensioners. Whether or not the pension plan is funded or unfunded is the greatest determinant of its financial health.

If a pension plan is unfunded, it means that there are no assets that have been set aside  and so, the benefits will be paid for by the employer or other pension sponsor as and when they are paid. The contributor needs to make contributions and invest assets in the capital markets so as to keep it at a healthy funding status.

Funded pension plans can also be advanced. An advanced funded pension plan is that which is funded concurrently with the benefits accumulated by employees. The funds in these types of plan are set aside and accounted for well, until the time the employees retire.

Funded and unfunded pensions: The difference

A well-defined pension plan is usually the funded plan, that which has enough assets to pay its obligations to retirees for the foreseeable future. This kind of fund has enough money on hand that has been invested responsibly. The return on such investments and the assets of the fund should be able to pay for all the benefits of the plan in the future. These kinds of pension plans also depend on continuous and new contributions so as to continue paying retirement benefits for all qualifying employees.

An unfunded pension plan is the total opposite of the one explained above. This kind of plan does not have enough income or assets to fund its obligated retirement benefits. Some of these plans come as a result of budget issues in an organization or employers failing to contribute enough funds to the accounts that already exist.

Why are they important?

Employers have an obligation to make contributions to their employee’s pension plans. Some employers do not make enough contributions as required while others do not make any payments at all to the existing accounts. It is important for employees to know whether their pension plans are funded or unfunded. Sometime back, organizations were required to reveal the contributions they were required to make to their pension plans. Nowadays we have agencies, which reveal underfunded pension plans and how underfunded these plans are. This revelation is important as it determines the confidence employees have in their employers, their retirement package and the organization in general.

An unfunded pension liability lacks the financial ability to make current or any future benefits to pensioners. Considering how important retirement pension is to retirees, it is important to be aware of the status of your pension plan at all times.