The Benefits of Overfunded Pension Plans: Why Having More Than Enough Funds Is a Good Thing

The Benefits of Overfunded Pension Plans: Why Having More Than Enough Funds Is a Good Thing

January 12, 2024

Underfunded pension plans typically get all the attention—and for good reason. These plans cause some serious problems for business owners. 

But what about overfunded plans? Although more rare, this type of plan occurs when assets are greater than the future payouts owed to plan participants. 

Overfunded pension plans are more than just an excess: they are a testament to prudent planning that offers comfort, flexibility, and a wealth of opportunity for both the employer and its employees. 

So, let’s dig deeper into the benefits of an overfunded plan and exactly what it means for a business owner. 

Reduced Financial Risk for the Employer

From the organization’s standpoint, having an overfunded status is much more desirable than being underfunded. An underfunded plan subjects the employer to increasingly higher minimum contributions to make up for the shortfall and potential benefit distribution restrictions. An underfunded plan also exposes the company to possible legal action from plan participants.

What’s more, there are many laws and legal requirements to maintain compliance and run a plan well. Having an overfunded plan can help the plan sponsor feel more confident and less likely to make costly mistakes that may impact the bottom line.

Resilience Against a Turbulent Market

Financial markets can be unpredictable and prone to swings and downturns. With its strategic surplus, an overfunded pension plan provides a buffer against this volatility. This cushion serves as a safety net to keep retirement plans intact even during economic turbulence.

CNBC recently credited strong stock performance for the dramatic improvement in pension funding over the past decade. But just as the market can contribute to the health of a pension plan, it can also have a disastrous effect during those inevitable downturns. While other plans may be at the mercy of external factors, an overfunded plan provides stability against the whims of the investment market.

Flexible Financial Planning

When it comes to retirement planning, we often seek that sweet spot—just enough funds to enjoy life without financial worries. An overfunded pension plan is about gaining flexibility in retirement decisions. It can grant the freedom to retire earlier, pursue passions, or make lifestyle choices knowing we can rely on our pension funds. 

Employees can use the overfunded status to plan their post-retirement life with more confidence, taking comfort that their payout amounts should remain stable throughout their lifetime. 

Fosters Trust 

What if your company’s pension plan didn’t just fulfill its obligations, but surpassed them? An overfunded pension plan can help boost employees’ trust in the financial stability of their employer, which fosters job satisfaction and deep-rooted loyalty.

By going above and beyond what’s typically expected, overfunded plans completely redefine trust within a company. Employees take comfort that their employer is confident and competent when it comes to running a successful business. 

Are There Any Complications?

Most people are skeptical of having too much of a good thing, which is why it’s also critical to consider the potential complications of an overfunded plan. Issues can undoubtedly arise when a defined benefit plan gets to the point where it is overfunded by hundreds of thousands or even millions of dollars.

Upon liquidation, the overfunded amount is subject to income taxes and an excise tax of 50%, equating to up to 90% in taxes paid back to the government. The money also cannot be withdrawn unless the plan is terminated. As a result, small business owners are often hit the hardest by these challenges.

How to Enjoy the Benefits of Overfunded Plans

The fact is that an overfunded pension plan can provide a sense of financial stability, versatility, and potential growth to retirement planning. But because every situation is unique, it’s important to get the right advice about overfunded plans to avoid potential complications. 

That’s why it’s critical to find the right partner. Our experienced team at FinancialFocus Retirement Plan Services is here to help. We partner with financial professionals to design and implement pension plans and provide guidance on defined benefit, defined contribution, and 401(k) plans.

Email me today at info@ff401k.com for a no-obligation evaluation.

About Kenny Phan

Kenny Phan is a Managing Partner/Pension Consultant at FinancialFocus Retirement Plan Services. He works as a pension specialist who partners with financial professionals to design and implement pension plans. His area of expertise is customized defined benefit, defined contribution, and 401(k) plans. Serving financial advisors and businesses around the nation, he is supported by FinancialFocus Retirement Plan Services. Together, they provide comprehensive plan design consultation, administration, document installation, compliance testing, as well as IRS and DOL reporting for qualified retirement plans.