Funded Status
Funded status is the measure of a defined benefit pension plan's financial health, expressed as the ratio of the plan's assets to the present value of its accumulated or projected benefit obligations, indicating whether the plan has sufficient assets to cover its existing commitments to plan participants.
The funded status of a defined benefit pension plan is the most critical single metric for understanding the financial position of both the plan and the sponsoring employer. A plan with a funded status above 100% — assets greater than liabilities — is described as overfunded, meaning it has a surplus. A plan with funded status below 100% is underfunded, meaning the present value of obligations to current and former employees exceeds the assets set aside to meet them.
In the U.S., funded status is measured and reported under two distinct frameworks that produce different results. For corporate defined benefit plans, GAAP accounting under ASC 715 (formerly SFAS 87 and 158) requires plans to measure liabilities using a discount rate derived from high-quality corporate bond yields, specifically a blend of AA-rated corporate bond yields reflecting the duration of the benefit obligation. For funding purposes under the Pension Protection Act of 2006 (PPA), a different smoothed interest rate corridor is used, generally producing a less volatile funded status measure. For public-sector pension plans, Governmental Accounting Standards Board (GASB) Statement 67 requires a discount rate based on the expected return on plan assets for the funded portion and a municipal bond rate for the unfunded portion.
The funded status has direct financial and legal consequences for U.S. plan sponsors. Corporate plans falling below 80% funded status under PPA rules trigger restrictions on lump-sum payments and benefit accruals. Plans below 60% are considered critically underfunded and face additional benefit restrictions. The Pension Benefit Guaranty Corporation (PBGC), which insures U.S. corporate defined benefit plans, charges variable rate premiums based on the plan's underfunding, creating a direct financial incentive for sponsors to maintain funded status.
For plan participants, the funded status determines the security of their promised benefits: a well-funded plan with a strong plan sponsor presents minimal risk of benefit impairment, while an underfunded plan sponsored by a financially distressed company represents meaningful risk that benefits may be reduced if the plan is terminated and insurance recoveries fall short of full benefit amounts.
Investment strategy for a defined benefit plan is heavily shaped by funded status, particularly in the context of liability-driven investing. Plans with improved funded ratios systematically de-risk — reducing equity allocation and increasing liability-matching fixed income — to protect achieved surplus and reduce the probability of funded status deterioration.