WHAT IS 'Allocated Funding Instrument'

Allocated funding instrument is a type of insurance or annuity contract that pension plans use to purchase retirement benefits incrementally.

BREAKING DOWN 'Allocated Funding Instrument'

Allocated funding instruments are funded with employer contributions that are paid into the plan. The benefits that are purchased by the funding instrument are guaranteed to employees at retirement. Pension plans that do not use allocated funding instruments use unallocated instruments instead. In these plans, there are no employer contributions available to purchase benefits before retirement. This means that no benefits are paid for at the time that the premium payments are actually made.

Pension plans

A pension plan is a retirement plan that requires an employer to make contributions into a pool of funds set aside for a worker's future benefit. The pool of funds is invested on the employee's behalf, and the earnings on the investments generate income to the worker upon retirement. In addition to an employer's required contributions, some pension plans have a voluntary investment component. A pension plan may allow a worker to contribute part of their current income from wages into an investment plan to help fund retirement. The employer may also match a portion of the worker’s annual contributions, up to a specific percentage or dollar amount.

Two main types of pension plans

In a defined-benefit plan, the employer guarantees that the employee receives a definite amount of benefit upon retirement, regardless of the performance of the underlying investment pool. The employer is liable for a specific flow of pension payments to the retiree (the dollar amount is determined by a formula, usually based on earnings and years of service), and if the assets in the pension plan are not sufficient to pay the benefits, the company is liable for the remainder of the payment. American employer-sponsored pension plans date from the 1870s, and at their height, in the 1980s, they covered nearly half of all private sector workers. About 90% of public employees, and roughly 10% of private employees, in the U.S are covered by a defined-benefit plan today.

In a defined-contribution plan, the employer makes specific plan contributions for the worker, usually matching to varying degrees the contributions made by the employees. The final benefit received by the employee depends on the plan's investment performance: The company’s liability to pay a specific benefit ends when the contributions are made. Because this is much less expensive than the traditional pension, when the company is on the hook for whatever the fund can't generate, a growing number of private companies are moving to this type of plan and ending defined-benefit plans. The best-known defined-contribution plan is the 401k, and its equivalent for non-profits' workers, the 403b.

RELATED TERMS
  1. Pension Plan

    A pension plan is a retirement plan that requires an employer ...
  2. Unit Benefit Plan

    A unit benefit plan is an employer-sponsored pension plan with ...
  3. Unit Benefit Formula

    Unit benefit formula is a method of calculating an employer's ...
  4. Unfunded Pension Plan

    An unfunded pension plan is an employer-managed retirement plan ...
  5. Pensionable Service

    Pensionable Service refers to the amount of time a worker accrues ...
  6. Statement Of Changes In Net Assets ...

    A Statement Of Changes In Net Assets Available For Pension Benefits ...
Related Articles
  1. Retirement

    Florida's Surprisingly Flexible State Retirement System

    Retired Florida employees can choose a 401(k)-style investment plan or a traditional pension.
  2. Retirement

    A Primer On Defined-Benefit Pension Plans

    Most of us will rely on a pension plan in the future, so it's best to know the details of the various plans before signing up.
  3. Retirement

    America's Frozen Pension Dilemma

    Unfortunately, there are several factors that have eroded the presence of pension plans in America, and workers need to be prepared to replace that expected income for their retirement years. ...
  4. Retirement

    How Safe Is Your Pension?

    A 2014 law permits some private pension plans to reduce benefits. How to figure out if your retirement income is endangered.
  5. Retirement

    More Pension Plans in the Deep Freeze

    A growing number of Fortune 500 companies have sent their defined-benefit pension plans to the deep freeze. What employees should do next.
  6. Retirement

    7 Signs Your Pension Fund Is In Trouble

    Even if you're lucky enough to have a pension plan, you can't assume it'll pay out.
  7. Retirement

    What to Do If Your Pension Is Frozen or Terminated

    Here's what needs to be considered if your employer freezes or terminates your pension.
  8. Retirement

    How to Spot Pension Fraud Before It Hurts You

    Don't let pension fraud threaten your livelihood after retirement. Here's what to watch out for.
  9. Retirement

    Can Your Pension’s Cost-of-Living Clause Be Frozen?

    Recent events in New Jersey prove that relying on a pension alone to fund your retirement is risky. Make sure you have multiple retirement income sources.
RELATED FAQS
  1. What are qualified retirement plan types?

    Understand the different types of qualified retirement plans and what they mean in terms of employee and employer contribution ... Read Answer >>
Trading Center