Funded vs. Unfunded Pensions
If you’re like millions of workers in the United States relying on a pension plan to carry you through your retirement years, you may be concerned with just how funded your pension actually is. Because you’ve worked hard for a leisurely retirement, the last thing you want to find out is that your guaranteed pension is in jeopardy or under-funded. When your pension is funded, you will receive your pension benefits without hiccups because the plan has enough assets to cover current and foreseeable future payments. However, if your pension is unfunded, there may not be enough to cover these payments.
Fully funded pensions have enough assets to fulfill current and future retirement benefit payments. This is in contrast to unfunded pensions, which do not.
Overview of Funded Pensions
A pension plan is similar to a 401(k) as both are used as retirement vehicles, however, they’re actually quite different. Known as defined benefit plans, pensions pay recipients a certain amount of guaranteed monthly income after they retire, whereas a 401(k) is a defined contribution plan and does not guarantee how much you will receive after retirement. Exactly how much you will receive in monthly pension is typically dependent upon your average salary and how long you worked. But it’s worth noting, not all pension plans are created equal, so it's best to familiarize yourself with your particular plan well before you retire.
When your pension is funded properly, this means your pension will be there when you’re ready to begin your journey on the road of retirement, and there is no looming threat that everything you worked so hard for might be lost. The assets in funded pensions are held in a trust and then reasonably invested in various stocks, mutual funds and bonds. Although a portion of pension payouts come from employee contributions, employer contributions make up approximately 26 percent of these payouts, while the lion’s share – or 62 percent – comes from investment earnings.
What Are Unfunded Pensions?
In a nutshell, an unfunded pension is one that cannot entirely fulfill its obligation to pay retirement benefits to retirees. A pension could be unfunded, or under-funded, for a number of reasons such as poor investment returns, mismanagement and even corruption. Pensions can be public or private, with public or government pensions considered safer than those offered by private companies, which can go out of business or otherwise default on pension benefit payments. State and local governments can also default on public pension payments, though this only happens in extreme cases.
Private pension plans are partially insured through the Pension Benefit Guaranty Corporation, a government entity created in 1974 to assure retirees receive pension benefits in the event their employer goes bankrupt or otherwise defaults. The PBGC does not guarantee that it can pay all the benefits you’re entitled to, and does have a maximum benefits payout calculated by various factors.
Determining the Funded Ratio
The amount a pension is unfunded is expressed by what is known as the funded ratio. To determine the funded ratio, divide your plan's assets by the amount of benefits it has to pay. A ratio of 100 percent is ideal as this means your plan has enough available assets to fulfill its current and future benefit payments. Strictly speaking, a plan with less than 100 percent funded ratio means that currently the pension doesn't have enough assets to cover future payments.
Check with the fund's website or contact a plan administrator to find out the fund ratio or how to gather the information to calculate it on your own. The higher the funded ratio, the better shape your plan is in, and a funded ratio of 80 percent or above is generally accepted as solid, but many factors determine your plan's soundness.
Diversify Your Portfolio
It’s a wise decision not to have all of your retirement eggs in one nest. You may want to consider the advice of a qualified financial planner who can help you best determine how to plan for your retirement. While having a pension is certainly a nice addition to your retirement portfolio, things can happen, so ensuring you have other streams of retirement income will give you the peace of mind needed to enjoy a carefree retirement.
Tara Thomas is a Los Angeles-based writer and avid world traveler. Her articles appear in various online publications, including Sapling, PocketSense, Zacks, Livestrong, Modern Mom and SF Gate. Thomas has a Bachelor of Science in marine biology from California State University, Long Beach and spent 10 years as a mortgage consultant.