It’s easy to understand why pension participants get confused looking through their annual plan funding notices. The notice presents several different measures of the plan’s funded status and provides details for multiple measurements at different points in time. In a new article entitled “Funded status measurements for U.S. pensions,” Zorast Wadia explains these types of measurements.
The article was written as an introductory piece for an international audience, providing perspective on funded status measurements under U.S. Internal Revenue Service (IRS) pension funding rules.
Here is an excerpt:
Funded status measurements
Several funding status measurements can possibly be derived from reading an annual funding notice. Each of the following funded status measurements involves comparing a plan’s asset measure to its liability measure, and often the comparison is made with and without respect to the inclusion of credit balances. Exactly which components are used within a particular funded status measurement is quite important. The various permutations on funded status measurements that exist can make this subject a little complicated and somewhat burdensome to explain to the non-pension practitioner.
Measurement Number 1: Actuarial value of assets compared to the funding target
These results appear on the first page of the funding notice and are shown for the last three years. If a plan’s actuarial value of assets is greater than or equal to a plan’s target liability, the plan is generally considered well funded and free of potential benefit restrictions. Depending on their nature, benefit restrictions may limit distribution options, benefit improvements or benefit accruals. If a plan’s actuarial value of assets is less than the target liability, then things start to get a little more complicated and this often leads to a more refined measure of the plan’s funded status.
Measurement Number 2: Actuarial value of assets reduced by the credit balances compared to the funding target
This funded status measurement is shown on the funding notice and often results in a highly skewed funding measure, depending on the size of a plan’s total credit balance. A plan may only be slightly underfunded when comparing just the actuarial value of assets with the target liability, but may be greatly underfunded when one subtracts credit balances from the asset value. This key measurement often determines whether a plan faces benefit restrictions. This measure may also determine whether a plan will need to make minimum funding contributions on an accelerated basis in the following year. Lastly, it can also have a great impact on the calculation of the amortization cost or credit component of the minimum funding requirement.