What is a Pension Shortfall?

A pension shortfall exists when a company does not have enough money set aside in order to cover the obligation it has to its employees to pay pensions. A pension is a residual payment that an employee receives on a regular basis, usually monthly, after he retires from his regular job. These residual payments are paid by employers out of a pension fund that is explicitly set aside for this purpose. If the pension fund does not have enough money in it to meet all of the obligations an employer expects, this shortfall can exist.

Within the United States, not all employers offer pensions and no law requires them to do so. Some employers offer a pension voluntarily as a benefit to employees, in order to attract qualified or skilled workers. Others provide a pension as a result of negotiation and demands on the part of labor unions.

Although companies aren't required by law to provide pensions, the law does set rules once a pension fund has been set up. Because employees come to depend on the promised pension, the Employee Retirement Income Security Act (ERISA) regulates the availability of pension funds in situations when a pension has been created. Under ERISA, employers that offer a pension plan must have that plan vest after a given period of time. Once the pension vests for a particular employee, the employer is not legally permitted to withdraw the pension and he must pay the pension in full as promised.

Because companies are legally obligated to pay these vested pensions, a pension fund must be set up to ensure the money is available. The fund must have enough cash in it to ensure that the pension obligation can be met for all vested employees and all employees currently receiving a pension. If the funds are not sufficient, a pension shortfall occurs.

A pension shortfall can occur for a number of reasons. A company who invests the pension in the stock market or in shares of company stock may experience a pension shortfall, for example, if the stock market investments decline in value or if the company stock declines in value. When this pension shortfall exists, the company will still be obligated to make the payments it has promised to employees. It must do so out of its earnings and income instead of drawing from the pension fund. In cases where employers go bankrupt or do not have the money to pay, state agencies who guarantee pensions will generally step in to make promised payments to employees as a last resort.