Employer pension plans come in two types, defined benefit and defined contribution plans. With a defined benefit plan, your employer puts money into the account and the plan administrator promises to pay each retiree a certain amount of money each month based on the contributions to the plan, as well as your length of time on the job. Funded or unfunded pensions are determined based on the level of assets and income belonging to the plan.
A defined contribution pension plan that has enough assets in the pension fund to pay its obligations for the foreseeable future is a funded pension. The fund should have enough money on hand, invested responsibly, so that the returns on investment as well as the assets of the fund will pay all of the retirement benefits of the plan for the future. Pension funds also depend on new contributions to the fund to continue paying pension benefits.
An unfunded pension plan, or more specifically an under-funded pension plan, is a defined benefit pension plan that does not have enough assets and income to pay out the benefits that it is obligated to pay. Unfunded pensions happen when companies or governments run into budget problems, or for other reasons choose not to contribute the required amount of money to the funds. Also, unfunded pensions occur when investments held within the pension fund lose a significant portion of their value due to market conditions
Under older accounting rules, municipalities had to reveal the contributions they were supposed to be making to their pension funds each year, and then reveal the amounts they were actually contributing. Under the current rules, government agencies must reveal how much the pension fund is actually underfunded. Pension administrators also must now reveal this unfunded liability by valuing assets at their current actual market value. Letting the public know that their pension fund is underfunded can have a significant effect on the confidence of the people covered by the pension plan.
Although it is definitely preferable to have a pension plan that is fully funded, a plan that is unfunded may not be as big of a problem as you might think. If the pension plan is able to pay all the benefits that it has promised, and the plan sponsor can make the payments to the plan that it has promised without causing financial stress to its budget, the plan sponsor can make up for the shortfall over time. This is also called amortizing the unfunded liability.
Defined Contribution Plans
If you have a defined contribution plan, you are responsible for funding the plan yourself, less any matching contributions your employer may make for you. While you have no requirements for funding these accounts, you must pay attention to the amount that you are contributing regularly, and make sure that the amount is sufficient to allow you to meet your retirement goals.