Pension Basics: Funded Status

Funded status measures the dollars a pension fund has received and invested, compared to the pension payments it needs to make.

Government employers have made promises to public workers, that at retirement they will get guaranteed monthly income for life. But how do pension plans keep these promises? It all starts with one of the most important measurements a pension plan has: funded status.

Measurement 1: Funded Ratio

The funded ratio is simply the value of assets in a pension fund divided by the value of promised lifetime income benefits.
If a pension plan has promised $1 billion in pensions, then in a perfect world it has $1 billion in assets to earn investments and make those payments. When a pension plan has 100% of the money it needs, that’s fully funded status.
If a pension plan has promised $1 billion in pensions, but only has $900 million in assets, that is just 90% funded. That isn’t a terrible thing for one or two years at a time, but if a pension plan stays below 100% funded for more than a few years in a row that means something is wrong.

Measurement 2: Unfunded Liabilities

This is the difference between the value of promised benefits and assets available to pay those benefits. This is the shortfall in assets that should be in the pension fund and invested so that all promised benefits can be paid.
A pension plan with $1 billion in promised benefits and $900 million in assets has $100 million in unfunded liabilities, or pension debt.

Measurement 3: Unfunded Liabilities As a Percentage of Local Economy

This is a way of thinking about how easily a government could backfill the pension funding shortfall and get debt eliminated. The larger the unfunded liability is as a percentage of a state’s economy, the harder it will be for the government to come up with money to quickly get the funded ratio back to 100%.
For example, the California teacher pension fund (called CalSTRS) has a shortfall of more than $100 billion, which is about 3.5% of the Golden State’s GDP. That is a lot of money and a pretty decent chunk of the state’s economy.
Meanwhile, the Mississippi Public Employees’ Retirement System has a roughly $17 billion funding shortfall. This is way less than California’s public pension debt, but it is 15% of the Mississippi economy. That makes it a bigger problem to deal with.

Challenges with Funded Status

In recent years, funded status has been less-than-perfect for most public pension funds, due to growing pressures that pension boards and legislatures have been slow to react to:

People are living longer, which means paying benefits longer than your pension board may have originally expected.
Governments have failed to pay all of their pension bills on time.
Investments made by your pension board haven’t performed as well as they predicted.

The result is a significant shortfall funded status. Government employers have to make up any shortfall in your pension fund’s assets, making debt payments.

In many states, the pension debt is billions of dollars. It’s getting harder to keep up — and you may be feeling it yourself. If you’re a public worker, your take-home pay might be getting smaller because you’re required to contribute more from each paycheck. Or raises might not feel as meaningful because your state has less money to increase pay. If you’re already retired and receiving a pension, you may be losing your COLA — or cost-of-living-adjustments — which helps you keep pace with rising prices.

Taxpayers may be feeling the decline in funded status too, just in ways not recognized. Property taxes might be up, road repairs might be delayed, or public investments in things like affordable housing or cleaner parks might be on hold.

This article is part of Equable’s Pension Basics series. To learn more about how your pension works, check out the other articles in the series:

1. How Pension Benefits Are Calculated

2. Vesting

3. The Pension Funding Formula

4. Assumed Rate of Return

5. Normal Cost

6. Unfunded Liabilities (aka Pension Debt)

7. Actuarially Determined Contributions

8. Paying the Pension Bill

9. Funded Status

10. Governance

11. Pension Myths & Facts: The Assumed Rate of Return Does Not Determine the Value of Benefits