Underfunded pension plans are a growing problem in the corporate world. They are defined as pensions which do not have enough money on hand to cover their current and future obligations. This is a major issue because pension promises to current and former employees are legally binding. Without enough money in the plan, the employer may be unable to pay out the promised amounts which leaves employees with uncertain retirements.

Underfunded pensions can occur for a variety of reasons. One of the most common causes of an underfunded plan is investment losses. Companies generally invest their pension contributions in the stock market in order to maximize returns. However, any investment carries risk and if investments have not performed as intended or have been overly aggressive there can be a significant decrease in assets. The large-scale retirement of the baby boomer generation has put an additional strain on many pension funds as retired individuals frequently or may require payouts to begin as soon as possible. This can deplete a fund more quickly than anticipated and leave pension plans underfunded.

Poor planning can also result in underfunded pension plans. When setting up a pension plan, companies must take into account several factors, such as the number of employees and their expected salaries. If the plan’s assumptions are incorrect and a company’s workforce is larger than anticipated, the costs to fund the pension can outstrip the company’s resources. Projections can also be miscalculated leading to an underfunded pension.

The consequences of an underfunded pension plan can be severe and far reaching. The company can face financial penalties and even lawsuits if they are unable to make promised payments to employees. Companies are legally obligated to take corrective steps to fund any underfunded pension plan and must pay any deficits as soon as possible. The company’s stock price can suffer as the news of an underfunded pension plan spreads and the company’s credit rating can take a hit due to the financial pressure.

The opposite of an underfunded pension plan is an overfunded pension plan. This is a situation when the company’s pension plan contains a surplus of assets to meet its obligations. Generally, this is considered the ideal scenario but can also be risky if the company invests the surplus in overly aggressive investments or fails to adequately track its plan’s investments.

In summary, underfunded pension plans can be a major issue for companies as they are unable to make good on their commitments to current and former employees. Underfunding can be caused by investment losses or poor planning and the financial, legal and reputational implications for the company can be substantial. Companies must take steps to ensure their pension plans are sufficiently funded and adequately managed in order to avoid being put in the unfortunate situation of having to explain an underfunded pension plan.