Definition of Overfunded Pension Plans and Examples
An overfunded pension plan is a retirement plan that has defined benefits and possesses more assets than its liabilities. An overfunded plan is on the right track to meet its financial obligations with flexibility.
How is an Overfunded Pension Plan Financed?
An overfunded pension plan may not become so by design, but it can happen. Many factors can increase the value of the fund to the point that it has surplus capital. Market conditions play a significant role in the value of the pension fund. For example, from March 2020 to June 2021, pension plans achieved returns of over 25% due to a significant stock market rally following the COVID-19 pandemic.
Interest rates can also lead to an increase in the value of the fund. If interest rates rise, fund managers can reduce their assumed liabilities, which can lead to increased growth of the fund.
Criticism of Overfunded Pension Plans
It is important to note that the funding status is not static. For instance, an overfunded pension plan can quickly become an underfunded one if interest rates decline.
Like all pension plans, pension funds are subject to stock market fluctuations because they rely on investments. This means that a decline in the stock market can shrink the total assets of the fund to a level below its liabilities.
It is also possible for the pension fund to be overly optimistic about its returns, preventing the plan from growing sufficiently to meet all of its future obligations.
For example, New Jersey’s public pension system was overfunded at the beginning of the 21st century. After taking steps such as increasing retirement benefits and reducing contributions from the state budget, the plan fell into a state requiring additional funding of billions of dollars from public contributions.
For reasons like these, managers of overfunded pension funds may be reluctant to withdraw money from the fund by increasing benefits or reducing contributions, even if it seems they have enough funds to do so. The main concern in taking such actions is that future market conditions are unpredictable, so any change may have drastic effects on the future value of the plan.
Key Takeaways
Overfunded pension plans are retirement plans that currently operate at a pace where they have enough money to pay the promised retirement benefits. An overfunded pension plan can quickly become an underfunded plan as conditions change, so plans must take into account what may happen if this surplus is utilized. Individuals with overfunded private pension plans may face additional taxes if the plan is terminated and remains overfunded.
Source: https://www.thebalancemoney.com/what-is-an-overfunded-pension-plan-5205152
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