May 26, 2014 at 1:00 am

Take notice of pension plan's status

Annual funding breakdown offers vital but possibly cryptic insights into future benefits

If you’re a participant in a pension plan, you’ve probably received or will soon receive what’s called the plan’s “annual funding notice.”

The notice, which employers are required to send each year to all plan participants, tells you:

■How well your pension is funded.

■The value of your pension plan’s assets and liabilities.

■The total assets and liabilities of the plan for the current year and the two preceding years.

The key question we all want answered is: Does the pension plan have enough money to pay its participants? Specifically, will it be able to pay me my benefits when I retire?

The annual funding notice is supposed to give an idea of the plan’s financial health, but it’s not that easy to understand.

“The intent was to provide meaningful information, but it’s a challenge to interpret,” said Bruce Cadenhead, chief actuary for the U.S. retirement, risk and finance business of Mercer, a consulting firm. “You’ve got two sets of numbers, and they look very different.”

Before I get into those two sets of numbers, it’s important to understand pension plans and how interest rates affect a fund’s obligations.

“A pension plan is a series of payments that companies are going to make in the future — as many as 50, 60, 70 years out into the future,” said Donald Fuerst, senior pension fellow at the American Academy of Actuaries.

To ensure that the plans have enough money to pay those future benefits, they must comply with minimum funding rules.

If the value of the plan’s assets is lower than its funding target, employers must contribute to the plan to cover the funding shortfall.

Contribution amounts are based on complicated formulas that take into account current and projected interest rates.

Low interest rates mean that employers have to contribute more money than expected into their pension plans. When rates are low, companies will earn less interest and so need to contribute more money to cover future pension benefits. Conversely, when rates are high, employers are able to earn more interest and need to contribute less money to the pension plan.

This is why interest rates are key to interpreting the two figures Cadenhead referred to, both of which are in the “MAP-21 Information Table” portion of the pension funding notice.

MAP-21 stands for the Moving Ahead for Progress in the 21st Century Act, which became law in 2012.

The law is primarily known for authorizing funding for the nation’s highways and for extending low interest rates for federal student loans. But it also included a package of pension provisions.

The law changed the required interest rate companies use to calculate their pension liabilities to one based on a 25-year average.

Since the 25-year average rate is higher than today’s market rate, the end result is that employers are required to contribute less money to their plans.

So in the MAP-21 information table, you have two figures: one that calculates how well your plan is funded using the MAP-21 interest rates, and one calculated without.

Which figure gives a more accurate picture of a pension’s financial health?

The one calculated without the MAP-21 rate, Fuerst said.

“Look at those for the three years (the current year plus the two preceding). They’re based on market rates, and that gives you some meaningful insight into how the funded status of the plan is changing over those three years,” he said.