What Is Fully Funded?
Fully funded is a term that describes when a pension plan has sufficient assets to provide for all accrued benefits and meet future obligations. In order to be fully funded, the plan must be able to make all the anticipated payments to both current and prospective pensioners. A plan's administrator is able to predict the amount of funds that will be needed on a yearly basis. This can help determine the financial health of the pension plan.
Fully funded can be contrasted with an underfunded pension which does not have enough current assets to fund its obligations and an unfunded pension plan which is pay-as-you-go (defined-contribution) type of retirement plan.
- Fully funded is when a defined-benefit pension plan has enough assets on hand to satisfy all obligations to current and future retirees.
- Companies strive to reach fully funded status so they do not experience shortfall of funds promised to workers.
- A fully funded pension plan status will be indicated in the company's financial statement footnotes.
Understanding Fully Funded
A fully funded pension plan is one that has the financial stability to make current and future benefits payments to pensioners. The plan depends on capital contributions and returns on its investments to achieve stability. Companies distribute annual benefits statements specifying whether or not the pension plan is fully funded. As such, employees can determine the financial strength of the plan.
A plan's funded status refers to the amount of accumulated assets (out of all assets needed for full funding) that have been set aside for the payment of retirement benefits. The equation to determine a plan’s funded status is:
Funded Status = Plan Assets - Projected Benefit Obligation (PBO)
For example, in April 2018, the CalPERS (California Public Employees’ Retirement System) fund had a funded status of 68% at the end of the June 30 fiscal year. This was flat from a similar 68.3% on June 30, 2016, according to the plan’s reports. In April 2018, the size of the CalPERS fund was $351.5 billion.
Underfunded pensions are a growing problem as they are unable to meet the pension cash flows promised to current and retired workers. An overfunded, on the other hand, pension plan is a company retirement plan that has more assets than liabilities. In other words, there is a surplus amount of money needed to cover current and future retirements. Although the surplus can legally be recorded as company income, it cannot be paid out to corporation shareholders like other income as it is reserved for current and future retirees.
Certain plans are unfunded plans (also called pay-as-you-go arrangements). These do not have any assets set aside, meaning that retirement benefits are usually paid directly from employer contributions.
Fully Funded and the Pension Footnote in Financial Statements
The pension note in a company’s financial statements details the corporate pension plan that management has set for its employees, generally after a particular vesting period. This usually follows after the section on long-term liabilities, since the pension fund is a particular type of long-term liability that is not often captured on the balance sheet. For this reason, many say that pensions are a type of off-balance-sheet financing.
Pension fund accounting is complicated, and the footnotes are often tortuous. There are various sorts of pension plans, but the defined benefit pension plan is one of the most popular. With a defined benefit plan, an employee knows the terms of the benefit that he or she will receive upon retirement. The company is responsible for investing in a fund in order to meet its obligations to the employee, so the company bears the investment risk.
On the other hand, in a defined contribution plan, such as a 401(k), the company probably makes contributions or matching contributions, but does not promise the future benefit to the employee. As such, the employee bears the investment risk.