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How to Calculate the Funded Status of a Pension Plan

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  • 0:04 Defined Benefit Pension Plans
  • 1:06 Funded Status
  • 1:58 Plan Assets
  • 2:36 Projected Benefit Obligation
  • 3:32 Putting It All Together
  • 4:10 Lesson Summary
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Lesson Transcript
Instructor: James Walsh

M.B.A. Veteran Business and Economics teacher at a number of community colleges and in the for profit sector.

The funded status of a pension plan is the fair value of the plan's assets minus the present value of its projected benefit obligation. We will use an example to calculate both and determine if the pension fund is over or under funded.

Defined Benefit Pension Plans

Say Consolidated Soft Drink Company is the bottler of a full line of refreshing soft drinks. ConSoft, as they are commonly known, was a pioneer in getting the sugar out of soft drinks and making them healthier for consumers to enjoy. Maria has worked on the line at a bottling plant for 30 years. She is proud of her work and what the company has done to make the beverages healthier. Maria plans to retire at the end of the year.

ConSoft provides a defined benefit pension plan for its employees. That means Maria is entitled to receive a specific amount of benefits each month until she dies based on her pay rate and years of service. It's up to ConSoft to make sure there are enough funds set aside to pay all of the pensioners what they have been promised.

Every year Maria gets information from the company about the funding status of the pension plan. This year she wants to really understand what it means! Let's go through one of those statements with Maria and get to the bottom of those numbers.

Funded Status

The funded status of a pension plan is the fair value of the plans assets minus the present value of its projected benefit obligation.

  • The fair value of plan assets is straightforward, it's the fair value of the funds invested to pay pension obligations. These are often invested in financial assets like stocks, bonds, and government securities.
  • The present value of the projected benefit obligation (PBO) is how much the company anticipates it will have to pay out to present and future retirees discounted to the statement date. If the funded status is positive (as in, assets exceed PBO) it creates a net pension asset on the balance sheet; if negative (as in, PBO exceeds assets) the plan is underfunded, and a net liability is created.

Let's look at the two major pieces in detail.

Plan Assets

Maria opens up her pension information package from ConSoft and looks at the assets part. What she finds is presented on the table below:

Fair value of pension assets Amount in millions Explanation
Opening fair value of plan assets $320 The fair value of plan assets at the beginning of the year
Contributions received $40 This is the company contribution for this year
Benefits paid ($30) This is how much was paid out to pensioners this year
Actual return on plan assets $20 This is how much plan assets gained in market value
Closing fair value of plan assets $350 This is the end of year plan assets

As you can see in the table, fair value of plan assets started at $320 million, the company contributed $40 million, paid out $30 million to pensioners, but then gained $20 million in market value, ending at $350 million, $30 million more than the year started with.

Well that looks pretty good to Maria - the plan assets increased this year! Now she needs to look at the other half of the picture - the plan's obligations.

Projected Benefit Obligation

ConSoft's PBO information is presented on the table below:

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