ERISA Funding Rules: How a Pension Stays Solvent

A defined-benefit pension plan does not simply collect contributions and pay them out on demand. Federal law — specifically the Employee Retirement Income Security Act of 1974, known as ERISA — imposes a continuous, actuarially grounded obligation on every private-sector plan to hold enough assets to cover the benefits it has already promised. That obligation is not voluntary, and it does not wait for a plan to fall into crisis before it activates.

This piece covers the funding side of that machinery: how ERISA measures whether a plan is adequately funded, what triggers a mandatory contribution from the plan sponsor, how the federal pension insurer fits into the picture, and where the system produces results that participants do not expect. The payout formula that determines what a participant is owed — the separate question of how a benefit accrues — is a distinct mechanism covered by ERISA's accrual rules.

How ERISA Measures and Enforces Minimum Funding

ERISA's funding requirements, as significantly strengthened by the Pension Protection Act of 2006, are built around a single ratio: the plan's "funding percentage," which compares the fair market value of plan assets to the plan's "funding target." The funding target is the present value of all benefits earned to date by all participants, calculated using interest rates published by the IRS and actuarial assumptions approved under the statute. When that ratio falls below 100 percent, the plan is considered to have a "funding shortfall."

A plan with a funding shortfall is required to make minimum contributions sufficient to amortize that shortfall over seven years, in addition to covering the normal cost of benefits accruing in the current year. The normal cost is itself an actuarial figure — the present value of benefits that participants earn during the plan year under the defined-benefit formula the plan uses. Both figures are recalculated each year by the plan's enrolled actuary.

The IRS enforces the minimum funding requirement through an excise tax. If a plan sponsor fails to make the required minimum contribution by the statutory deadline — generally 8½ months after the close of the plan year — a 10 percent excise tax applies to the unpaid amount. A second-tier excise tax of 100 percent applies if the failure is not corrected. These taxes are imposed on the plan sponsor (the employer), not on the plan itself or on participants.

ERISA also imposes "benefit restrictions" when a plan's funding level falls below certain thresholds. At a funding percentage below 80 percent, the plan is prohibited from paying accelerated lump-sum distributions beyond a statutory limit. Below 60 percent, the plan must freeze all further benefit accruals. These restrictions operate automatically by statute; the plan administrator does not have discretion to waive them. Participants who were counting on a lump-sum option or on continued accrual can find those features suspended without any action on the plan's part beyond falling below the threshold.

Interest rate assumptions are central to the entire calculation. The funding target is a present-value figure, so a lower assumed interest rate produces a larger funding target and a larger apparent shortfall. The IRS publishes the segment rates used in this calculation monthly, derived from corporate bond yields. A sustained period of low interest rates mechanically increases the measured liabilities of every defined-benefit plan, even if the plan's investments perform well.

Who Administers the Funding Obligation and Who Backs It

Three distinct parties carry defined roles in the funding framework.

The plan sponsor — typically the employer, or the group of employers in a multiemployer arrangement — bears the legal obligation to make required contributions. In a single-employer plan, the sponsor's obligation is backed by its own financial capacity. ERISA allows the Department of Labor and the IRS to pursue the sponsor directly for unpaid contributions, and a lien in favor of the plan attaches automatically when contributions go unpaid beyond 60 days after the due date.

The enrolled actuary is a credentialed professional who certifies the plan's actuarial valuation each year. That certification, filed with the IRS on Schedule SB of Form 5500, is the document that establishes the funding target, the normal cost, and the required minimum contribution. The actuary selects assumptions — mortality tables, turnover rates, retirement age distributions — within ranges permitted by the statute. Different assumption choices within that range can produce meaningfully different required contribution amounts, which is why the enrolled actuary's role carries regulatory accountability.

The Pension Benefit Guaranty Corporation (PBGC) is the federal agency that insures most private-sector defined-benefit plans. It is not part of the funding enforcement mechanism, but it is the backstop when that mechanism fails. If a plan sponsor becomes insolvent and the plan is terminated with insufficient assets, the PBGC takes over the plan and pays benefits up to statutory maximum amounts. For 2024, the PBGC maximum for a single-employer plan at age 65 is $7,107.95 per month. That ceiling means participants in well-funded plans with high benefit formulas can receive less than their full accrued benefit if the plan fails. The PBGC is funded by insurance premiums paid by plan sponsors — not by general tax revenues — and its own financial condition is a separate matter from the solvency of any individual plan.

The plan administrator — which may be the employer itself or a separate administrative entity — is responsible for filing required notices with participants when the plan's funding status triggers benefit restrictions, and for annual reporting to the DOL and IRS. As explained in the broader overview of what ERISA requires of a pension plan, the administrator's fiduciary duties extend to the accuracy and timeliness of those disclosures.

Where the Funding Rules Break Down or Produce Unexpected Results

The most persistent source of friction is the gap between a plan's actuarial funding status and its economic reality. A plan can be certified as 100 percent funded under the statutory interest-rate assumptions while holding assets that, at current market yields, would not actually cover its liabilities. This is not fraud; it is a feature of the law's use of smoothed, averaged segment rates rather than spot market rates. The result is that funding status as reported on a Form 5500 is a legal measure, not a market-value measure.

Multiemployer plans — those covering workers from multiple employers under a collective bargaining agreement — operate under a separate, more permissive funding framework under ERISA and the Multiemployer Pension Reform Act of 2014. A multiemployer plan in "critical" status is permitted to reduce certain adjustable benefits (such as early retirement subsidies) even for participants who have already accrued them. This is a significant departure from the single-employer rules, where accrued benefits cannot be reduced. Participants in critical-status multiemployer plans receive notices of potential benefit reductions, but the reductions can take effect before a plan terminates.

The benefit restriction thresholds apply to the plan as a whole, not to individual participants. A participant who reached retirement age and was entitled to begin collecting benefits is not affected by the lump-sum restriction — but a participant who had not yet commenced benefits and was planning to elect a lump-sum distribution may find that option closed if the plan drops below 80 percent funded. The restriction lifts automatically when the funding percentage recovers, but there is no retroactive right to the lump-sum option for the period it was suspended.

Contribution waivers are available under ERISA Section 303(c) when a plan sponsor faces "temporary substantial business hardship." A waiver defers the required contribution; it does not eliminate the shortfall. Waived amounts must be amortized in subsequent years, and a waiver requires IRS approval. A plan that receives multiple waivers in a short period can accumulate a growing amortization burden that compounds the funding problem rather than resolving it.

What the Annual Funding Notice Shows — and What It Does Not

ERISA requires the plan administrator to distribute an Annual Funding Notice (AFN) to all participants and beneficiaries within 120 days after the close of each plan year (or, for small plans, by the date the Form 5500 is filed). The AFN must state the plan's funding percentage for the current year and the two preceding years, the value of plan assets and liabilities, a description of any benefit restrictions in effect, and the plan's funding improvement or rehabilitation status if applicable.

The AFN expresses the funding percentage using the statutory segment-rate methodology, not a mark-to-market valuation. A participant reading an AFN that shows 95 percent funding is seeing a legally constructed ratio, not a statement that the plan holds assets worth 95 cents for every dollar of benefit it would owe if every participant retired today at market discount rates.

The AFN does not show an individual participant's accrued benefit amount. It does not show the PBGC maximum that would apply to that participant if the plan were terminated. It does not project whether the plan will be fully funded in future years. For the individual benefit amount, a participant must consult the plan's annual benefit statement, which is a separate document governed by separate ERISA disclosure rules.

The Form 5500 filed with the DOL — including Schedule SB, the actuarial information schedule — is a public document available through the DOL's EFAST2 system. Schedule SB contains the enrolled actuary's certification, the detailed actuarial assumptions, the funding target, and the minimum required contribution. The level of technical detail in Schedule SB is substantially greater than what appears in the AFN distributed to participants.

ERISA's funding framework is a set of legal minimums, not a market-value solvency test. The distance between those two things — a plan that satisfies the statute and a plan that could pay every promised benefit at today's prices — is where most of the complexity in defined-benefit pension finance actually lives.

Note: This explains how a retirement system works. It is not financial, tax, or legal advice, it is not specific to any individual's retirement, and it is not a substitute for a licensed financial, tax, or legal professional. Rules, ages, and dollar limits change by year — check the cited sources.