How Pension Plan Funding Works: Contributions, Shortfalls, and PBGC

Pension plan funding works by having the employer contribute money each year into a trust that is legally separate from the company, in an amount an enrolled actuary calculates by comparing the value of every benefit already earned by participants against what the trust currently holds. If the trust falls short, federal law requires catch-up contributions on a set schedule, imposes an excise tax on employers who don’t make them, and automatically restricts what the plan can pay out when funding drops below certain thresholds. The trust assets sit outside the employer’s general treasury, so creditors cannot reach them even in bankruptcy.¹

How the Annual Contribution Is Calculated

Each year an enrolled actuary runs two numbers against each other. The first is the funding target: the present value of every benefit participants have earned to date. The second is the current value of plan assets. The gap between them, if any, is the shortfall that drives the required contribution.²

The Assumptions Behind the Target

Two assumptions move the funding target more than any others. Life expectancy sets how many years the plan will be writing checks; the IRS requires actuaries to use federally prescribed mortality tables, currently based on adjusted MP-2021 improvement scales, so the number is not left to each sponsor’s judgment.³ Projected salary growth matters nearly as much, because most benefit formulas key off an employee’s highest-earning years.

Discount Rates

The discount rate translates future benefit payments into today’s dollars, and it is the single most powerful input in the whole calculation. A higher rate shrinks the present-value target and lowers the required contribution. A lower rate does the opposite.

Single-employer plans cannot pick their own rate. Federal law requires them to use three segment rates published by the IRS, each a 24-month average of high-quality corporate bond yields across short, medium, and long maturities. For plan years beginning in 2020 through 2030, those rates are held inside a corridor of 95% to 105% of 25-year average segment rates, a stabilization measure introduced by the American Rescue Plan and extended by the Infrastructure Investment and Jobs Act.⁴ The corridor keeps required contributions from swinging wildly when bond markets move.

How Assets Are Valued

Sponsors do not have to use the exact market price of plan investments on the valuation date. Federal law permits a smoothing method that averages fair market values over a period of up to 24 months. The smoothed value, however, cannot be lower than 90% or higher than 110% of the plan’s actual fair market value on that date.⁵ Smoothing cushions a single bad quarter, but it also means a plan can look healthier on paper than its portfolio really is.

What the Employer Actually Owes Each Year

The Employee Retirement Income Security Act sets the baseline, and the Pension Protection Act of 2006 raised the required funding levels.⁶ For an underfunded single-employer plan, the minimum required contribution each year is the sum of three pieces: the target normal cost (the value of benefits earned during the current year), a shortfall amortization charge, and any waiver amortization charge carried over from a previously granted waiver.² If plan assets already meet or exceed the funding target, the minimum drops to the target normal cost reduced by the surplus.

Closing a Shortfall Over 15 Years

A shortfall does not have to be closed in a single year. The original PPA rules amortized shortfalls over seven years, but the American Rescue Plan Act stretched that to 15 years for plan years beginning after December 31, 2021, and zeroed out all shortfall amortization bases from earlier years for a fresh start.² The longer runway shrinks each annual installment, at the cost of keeping underfunded plans underfunded for longer.

Quarterly Payments for Underfunded Plans

If a plan had a funding shortfall in the preceding year, the sponsor cannot wait until year-end. Four quarterly installments are required. Each equals 25% of the required annual payment, which is the lesser of 90% of the current year’s minimum required contribution or 100% of the prior year’s contribution.⁷ For a calendar-year plan, the due dates are April 15, July 15, October 15, and January 15 of the following year. Miss an installment and the plan can also run into a liquidity shortfall problem, where the IRS looks at whether enough liquid assets were on hand to cover the payment. Plans with 500 or fewer participants are exempt from the liquidity requirement.

What Happens If the Employer Underfunds

The Excise Tax

An employer that fails to meet the minimum funding standard owes an excise tax. For single-employer plans the initial tax is 10% of the aggregate unpaid minimum required contributions remaining at the end of the plan year. For multiemployer plans the initial rate is 5% of the accumulated funding deficiency.⁸ If the shortfall is not corrected within the taxable period, the rate jumps to 100% of the uncorrected amount.⁹ That is a cliff, not a slope, and it is designed to make ignoring the problem financially ruinous.

Automatic Benefit Restrictions

When a plan’s adjusted funding target attainment percentage crosses certain lines, federal law restricts what the plan can pay. The restrictions trigger by operation of law. No one has to file a motion.

Below 80%. The plan cannot adopt amendments that increase benefit liabilities. Lump sums and other accelerated payments are limited to the lesser of 50% of the payment amount or the present value of the PBGC maximum guarantee for that participant.¹⁰
Below 60%. All accelerated benefit payments are prohibited entirely. Benefit accruals freeze. Shutdown benefits and other unpredictable contingent event benefits cannot be paid.¹⁰

In practical terms, an employee at a plan sitting at 75% funding might only receive half of a lump sum in cash, with the balance converted to a monthly annuity. Below 60%, the lump-sum option disappears.

At-Risk Status

A plan enters at-risk status when its funding target attainment percentage for the preceding year was below 80% and its at-risk funding target attainment percentage was below 70%. Plans with 500 or fewer participants are exempt regardless of funding level. At-risk status increases the required contribution in two ways. The actuary must use more conservative assumptions, essentially assuming every eligible participant retires at the earliest possible date and takes the most expensive benefit form. And after five consecutive years in at-risk status, a loading of $700 per participant plus 4% of the standard funding target gets added on top.¹¹ For a plan with 5,000 participants, that loading alone can add $3.5 million or more to the funding target.

Overfunding, Deduction Limits, and Reversions

Employer contributions to a defined benefit plan are tax-deductible, but only up to a limit. For single-employer plans, the maximum deductible amount is the greater of (1) the sum of the funding target, target normal cost, and a cushion amount, minus plan assets, or (2) the minimum required contribution for the year.¹² Contributions above the deductible limit carry forward and become deductible in future years, but a 10% excise tax applies to the nondeductible portion in the year it is contributed.¹³ When the same employer also sponsors a defined contribution plan covering the same employees, a combined deduction limit under IRC §404(a)(7) may further cap what is deductible, though employer contributions to the defined contribution plan up to 6% of aggregate compensation are excluded from that combined cap.¹⁴

An overfunded plan sounds like good news, and mostly it is. The restrictions do not apply and minimum contributions can drop to zero. The problem comes when a sponsor wants to terminate a well-funded plan and recover the surplus. The standard excise tax on an employer reversion of plan assets is 20% of the amount reverted. That rate jumps to 50% unless the employer either establishes a qualified replacement plan covering at least 95% of the terminated plan’s active participants or provides pro rata benefit increases to participants worth at least 20% of the maximum reversion amount.¹⁵ With federal and state income taxes layered on top, the employer can easily lose more than half the surplus, which is why most sponsors either keep the overfunded plan running or roll the surplus into a replacement plan.

How to See a Plan’s Funding Level

The Annual Funding Notice

Every defined benefit plan must send an annual funding notice to participants. Large plans have 120 days after the end of the plan year. Small plans can wait until the Form 5500 filing deadline, including extensions, which can push the notice out roughly nine and a half months after the plan year ends.¹⁶ The notice compares plan assets against liabilities for the current year and two preceding years and reports the funding target attainment percentage. For an employee trying to gauge whether a future retirement check is secure, this is the document to read. A percentage trending downward across three years is a warning sign regardless of what the company says publicly.

Form 5500 and Schedule SB

Plan sponsors file Form 5500 with the Department of Labor annually. For calendar-year plans the normal deadline is July 31. Filing Form 5558 with the IRS grants an automatic extension of two and a half months, moving the deadline to October 15.¹⁷ If the plan year matches the employer’s tax year and the employer already has a federal income tax filing extension, the Form 5500 deadline matches automatically. Schedule SB is the actuarial attachment for single-employer defined benefit plans and reports asset values, the funding target, contributions made during the year, and the funding target attainment percentage. These filings are public records, so anyone can pull them.¹⁸

The Backstop: PBGC Insurance

The Pension Benefit Guaranty Corporation is the federal insurance backstop for private-sector defined benefit plans. If a company can no longer support its plan, the PBGC takes over and pays benefits up to a guaranteed maximum. Employers fund that insurance through annual premiums.

Single-employer plans pay two premiums for 2026. The flat-rate premium is $111 per participant regardless of funding status. The variable-rate premium is $52 for every $1,000 of unfunded vested benefits, capped at $751 per participant. Multiemployer plans pay a flat-rate premium of $40 per participant with no variable component.¹⁹

The guarantee is not unlimited. For a plan terminating in 2026, the maximum monthly benefit for a 65-year-old receiving a straight-life annuity is $7,789.77.²⁰ The ceiling adjusts downward for participants who retire before 65 and upward for those who retire later. Benefits increased by plan amendments within the five years before termination may also be reduced or excluded from the guarantee. Most retirees sit well below the ceiling and receive their full benefit; executives and long-tenured, high-salary employees are the ones most likely to collect less than the plan originally promised.

Corporate transactions can destabilize funding overnight, so federal law requires plan administrators and contributing sponsors to notify the PBGC within 30 days of certain reportable events, including changes to the plan’s controlled group, liquidation of a group member, and transfers of 3% or more of a plan’s total benefit liabilities to someone outside the controlled group.²¹ Missing the 30-day window can trigger penalties.

Funding Waivers

An employer facing temporary financial hardship can ask the IRS to waive the minimum funding standard for a given plan year. The application must demonstrate that the employer cannot meet the standard without substantial business hardship and that enforcement would harm participants as a whole. For single-employer plans, the request must be filed no later than the 15th day of the third month after the plan year closes. Multiemployer plans generally have until the close of the following plan year.

A waiver defers the obligation; it does not erase it. The waived amount becomes a waiver amortization charge folded into future years’ minimum required contributions.² The plan still has to make the money up, and participants will see the reduced funding reflected in the next annual funding notice.

1
U.S. Department of Labor. FAQs About Retirement Plans and ERISA
2
Office of the Law Revision Counsel. 26 USC 430 – Minimum Funding Standards for Single-Employer Defined Benefit Plans
3
Internal Revenue Service. Pension Plan Mortality Tables
4
Internal Revenue Service. Pension Plan Funding Segment Rates
5
Internal Revenue Service. Notice 2009-22 – Asset Valuation Under Section 430(g)(3)(B)
6
U.S. Department of Labor. Employee Retirement Income Security Act (ERISA)
7
eCFR. 26 CFR 1.430(j)-1 – Payment of Minimum Required Contributions
8
Office of the Law Revision Counsel. 26 USC 4971 – Taxes on Failure to Meet Minimum Funding Standards
9
eCFR. 26 CFR 54.4971-1 – General Rules Relating to Excise Tax on Failure to Meet Minimum Funding Standards
10
Office of the Law Revision Counsel. 26 USC 436 – Funding-Based Limits on Benefits and Benefit Accruals
11
eCFR. 26 CFR 1.430(i)-1 – Special Rules for Plans in At-Risk Status
12
Office of the Law Revision Counsel. 26 USC 404 – Deduction for Contributions of an Employer to an Employees Trust or Annuity Plan
13
Office of the Law Revision Counsel. 26 USC 4972 – Tax on Nondeductible Contributions to Qualified Employer Plans
14
Internal Revenue Service. Combined Limits Under IRC Section 404(a)(7)
15
Office of the Law Revision Counsel. 26 USC 4980 – Tax on Reversion of Qualified Plan Assets to Employer
16
U.S. Department of Labor. Field Assistance Bulletin No. 2025-02
17
Internal Revenue Service. Form 5558 – Application for Extension of Time to File Certain Employee Plan Returns
18
U.S. Department of Labor. Form 5500 Series
19
Pension Benefit Guaranty Corporation. Comprehensive Premium Filing Instructions for 2026 Plan Years
20
Pension Benefit Guaranty Corporation. Maximum Monthly Guarantee Tables
21
Pension Benefit Guaranty Corporation. Form 10 Instructions – Post-Event Notice of Reportable Events