Plan Sponsors Weigh Options for Pension Plan Funding

When it comes to optimizing the funding for a defined benefit pension plan, plan sponsors can take many different approaches. The best strategy depends on many factors, including funded status, plan goals and corporate objectives.

“For those that are working toward termination and want to shorten the time frame to termination, making discretionary contributions in tandem with adjusting their investment strategy can be very prudent from an overall corporate economic standpoint,” says Michael Clark, a Denver-based senior vice president at Gallagher. “For companies that are still years away from that, or who have open plans, it’s going to be a balance between the other corporate objectives and securing the pension obligations through those contributions.”

While plan sponsors should think of their defined benefit plan as a corporate liability and evaluate potential contributions as they might a capital project, pension funding is not purely a shareholder-value decision. Plan sponsors’ analysis also must consider market volatility.

“All of these decisions are [made] in a world of uncertainty,” says James Tamposi, a senior analyst at Cerulli. “A corporate sponsor could say, ‘We want to contribute to the pension funding plan to reduce funding status volatility,’ and then all of a sudden, interest rates go up a month later. In that case, maybe they would have been better off had they used those funds elsewhere.”

Determining the best approach to plan funding starts with prioritizing plan governance and having committee members who understand the plan’s impact on the balance sheet, as well as the company’s fiduciary obligations.

That means bringing in stakeholders from across the company, Tamposi says, including the chief financial officer, treasurer and members of the pensions team, to find alignment between priorities and to make the optimal decision for the company.

Evaluating Trade-Offs

At a minimum, Clark says, sponsors should plan on making contributions that cover the service cost and value of benefits accruing over the course of a given year pension fund investment returns are not doing that. From there, a committee can weigh the internal rate of return on pension contributions against alternatives for spending the same amount of money, such as paying down debt, repurchasing company shares or investing in mergers and acquisitions.

For example, for underfunded plans, making extra contributions that reduce variable-rate Pension Benefit Guarantee Corporation premiums can earn what is effectively a mid-single-digit return (5.2%), but that only makes sense if the company cannot reliably use the same cash to earn more elsewhere. Recent high investment returns have complicated the choice further.

“We’ve seen substantial increases in funded status just due to market movements alone,” Clark says. “So for a plan sponsor that’s considering putting in cash versus continuing to ride out the markets, it’s a tough decision.”

Optimizing plan funding does not always mean maximizing it. Once a plan no longer must pay PBGC premiums and is at or near full funding, each additional dollar put into the plan may have diminishing marginal benefits.

“In a vacuum, it’s very much dependent on the risk tolerance of the organization, the level of long-term commitment to maintaining the plan as a fully open plan, a partially closed plan or a fully closed plan,” says Matthew Eickman, an Omaha, Nebraska-based managing partner in the Fiduciary Law Center. “What might be optimal for one company with a plan very similar to another company may not be optimal for that other company because it depends on those other factors.”

Fully Funded Plan Options

For many plan sponsors, the goal is to reach plan funding of 105% to 110%—high enough to absorb market volatility and facilitate risk-transfer moves, but not so high that capital is inefficiently trapped in the plan, Tamposi says.

“Some of these plans are very well funded now, so shooting the moon and taking that risk on investment doesn’t make any sense because they already have significant overfunding and a contribution holiday for a long period of time,” says James Protopapas, a portfolio manager at Alight.

At that point, many plan sponsors start to think about shifting to a liability-driven-investment approach, which emphasizes long-term fixed-income investments over equities, to stabilize plan funded status and protect their gains. Plans going that route often use a glide path to gradually improve their funded status, while taking more risk off the table.

Then, when companies reach their desired funded state, they can explore options to completely de-risk, says Zorast Wadia, a New York City-based principal at Milliman.

Overfunded plans might also start looking at other ways to use or redeploy their plan’s surplus without triggering an excise tax. These strategies might include adding qualified replacement plans, offering retirees a cost-of-living adjustment or enhancing other benefits.

De-Risking Opportunities

The market in 2026 may also create an opportunity to remove some or all pension liability from a plan sponsor’s books by transferring some risk or terminating a plan entirely. For plan sponsors interested in keeping their company’s plan open, there may be an opportunity to re-evaluate their plan design.

More DB plan sponsors, for example, are moving toward cash balance plans, which limit liability growth while offering participants portable benefits, lump-sum or life annuity options, and an account balance structure similar to a 401(k).

“You have an account balance, and it grows with interest and grows every time a contribution is made,” Wadia says. “But you don’t have a highly leveraged final average pay-type design, and the risk is sufficiently shared between the plan sponsor and the plan participant.”