what is an underfunded pension plan 
an underfunded pension plan is a company sponsored retirement plan that has more liabilities than assets in other words the money needed to cover current and future retirements is not readily available this means there is no assurance that future retirees will receive the pensions they were promised or that current retirees will continue to get their previously established distribution amount an underfunded pension may be contrasted with a fully funded or overfunded pension understanding an underfunded pension plana defined benefit pension plan comes with a guarantee that the promised payments will be received during the employee s retirement years the company invests its pension fund in various assets in order to generate enough income to service the liabilities posed by those guarantees for both current and future retirees the funded status of a pension plan describes how its assets versus its liabilities stack up underfunded means that the liabilities or the obligations to pay pensions exceed the assets that have accumulated to fund those payments pensions can be underfunded for a number of reasons interest rate changes and stock market losses can greatly reduce the fund s assets during an economic slowdown pension plans are susceptible to becoming underfunded funding a pensionunder current irs and accounting rules pensions can be funded through cash contributions and by company stock but the amount of stock that can be contributed is limited to a percentage of the total portfolio no more than 5 of pension assets can be in any one company s stock 1companies generally contribute as much stock as they can in order to minimize their cash contributions however this practice is not sound portfolio management because it results in an overinvestment in the employer s stock the fund becomes overly dependent on the financial health of the employer even with the 5 limit such an amount in one company can make its success have a significant impact on the pension s success an underfunded pension plan should not be confused with an unfunded pension plan the latter is a pay as you go plan that uses the employer s current income to fund pension payments a plan is considered at risk for a plan year if the funding target attainment percentage for the preceding plan year is less than 80 and for the preceding year is 70 2the need to make this cash payment could materially reduce the company s earnings per share and therefore its stock price the reduction in company equity could even trigger defaults on corporate loan agreements this has serious consequences ranging from higher interest rate requirements to bankruptcy determining if a pension plan is underfundedfiguring out whether a company has an underfunded pension plan can be as simple as comparing the fair value of plan assets to the accumulated benefit obligation which includes the current and future amounts owed to retirees if the fair value of the plan assets is less than the benefit obligation there is a pension shortfall the company is required to disclose this information in a footnote in the company s 10 k annual financial statement 3there is a risk that companies will use overly optimistic assumptions in estimating their future obligations assumptions are necessary when estimating long term obligations a company may revise its assumptions as time goes on to minimize a shortfall and avoid the need to contribute additional money to the fund for example a company could assume a long term rate of return of 13 which would increase the funds expected to come from investments and reduce the need for a cash infusion in real life the long term return on stocks is about 10 and the return on bonds is even lower making the portfolio s overall return less than 10 4underfunded vs overfunded pensionsthe opposite of an underfunded pension is of course an overfunded pension a fund that has more assets than liabilities is overfunded actuaries calculate the amount of contributions a company must pay into a pension based on the benefits participants receive or are promised and the estimated growth of the plan s investments these contributions are tax deductible to the employer 5