Actuarial accrued liability (AAL): Total amount of promised pension benefits, counting up all expected pension checks for active members and retirees, and then reporting those in today’s dollars.
Also see: pension obligations, total pension liability
Actuarial assumptions: Estimates used to forecast uncertain future events affecting future benefits or costs associated with a pension fund. Examples of these assumptions include investment rate of return, inflation, payroll growth, mortality, retirement patterns, and other demographic data.
Actuarially Determined Contribution (ADC): The annual amount necessary to pay benefits plus expenses, after accounting for an assumed investment return (normal cost), plus the unfunded liability amortization payments.
(Previously known as “annual required contribution or ARC payment)
Actuarially Determined Employer Contribution (ADEC): The employer’s share of the ADC, after accounting for any employee contributions.
Actuary: Pension plans hire actuaries to measure the value of benefits, and determine contribution rates. A financial expert who specializes in mathematical and risk analysis.
Read more from the IRS
Adequacy Threshold: A measurement of how much future retirement income you should have accumulated at any given point in time, based on some targeted retirement goal in the future.
Assets: Money held by the retirement system to be invested and used to pay out benefits to retirees who have contributed to the system.
Assets, actuarial value (AVA): A “smoothed” value of assets, typically used for the purposes of determining contribution rates and measuring unfunded liabilities. Actuaries “smooth” any gains and losses of a particular number of years to minimize year-to-year changes in the value of the AVA. For example, actuaries typically smooth investment gains and losses over a five-year period, only recognizing 20% of the market valued return each year for the purposes of determining the AVA.
Similar terminology: actuarial value of assets
Assets, market value (MVA): The real value of the plan’s total assets, measured by the price that would be received to sell an asset in an orderly transaction between market participants at that date.
Also see: fiduciary net position
Similar terminology: market value of assets
Asset smoothing: The process of recognizing only part of an actuarial gain or loss to plan assets in any given year in order to calculate the actuarial value of assets. A pension plan might want to do this because amortization payments are based on the amount of unfunded liabilities, and smoothing in gains or losses to the plan’s assets means the recognized value of unfunded liabilities is unlikely to make a big jump from one year to the next.
Amortization: The process of setting a payment schedule for paying off unfunded liabilities. This is similar to a series of mortgage payments. When a pension fund has a shortfall—i.e. pension debt or unfunded liabilities—contributions are necessary to catch up on the appropriate amount of funding. These contributions are known as amortization payments.
Amortization Method: The process of determining how amortization payments will be made. Using a fixed contribution method, legislatures provide a fixed amount of contributions to pension plans and actuaries determine how many years it will take for that amount paid every year to eliminate unfunded liabilities and report that number. Using a fixed period of time method, pension funds determine a fixed period of time to pay off their debt, and then calculate the annual contributions needed to meet that goal.
Amortization method, closed: If an amortization schedule is “closed,” it has a particular number of years within which the unfunded liabilities will be paid off. Each year the pension plan pays off a portion of the amortization schedule and moves one year closer to its end date. If the pension plan experiences actuarial losses during the schedule that add to unfunded liabilities, the pension board could either create a separate amortization schedule for that new debt (known as an amortization “layer”) or simply add the new amounts owed to the existing debt and increase the payment in each year of the schedule without the number of years in the schedule increasing.
Amortization method, open: If an amortization schedule is “open” the payments are reset each year, like refinancing a mortgage. This approach virtually guarantees the pension debt will never be paid off and often can mean contributions towards unfunded liabilities each year don’t even cover the interest on the debt.
Amortization Payments: The contributions needed to catch up on the appropriate amount of funding when a pension fund has unfunded liabilities — i.e. pension debt or shortfall.
Amortization payments, level-dollar: Unfunded liabilities can be amortized over a fixed (closed) or open number of years such that the plan expects to pay the same dollar amount each year of the schedule.
Amortization payments, level-percent of pay: Unfunded liabilities can be amortized such that the plan expects to pay the same percentage of payroll each year of the schedule. Because most retirement systems anticipate payroll will grow over time, this method means that the dollar amount of amortization payments will be expected to grow too.
Annuity, annuitization: A permanent, fixed stream of future income payments. Pension payments are a form of annuity. Contracts between individuals and financial companies, where individuals make a payment to a company in exchange for a certain amount of lifetime income, are another form of annuity. All or a portion of the accumulated balance of an individual retirement account (such as a guaranteed return plan or defined contribution plan) can be converted into guaranteed lifetime income through a process called annuitization.
To read up more on the various kinds of annuities and how they work, check out Investopedia for details.
Assumed Rate of Return (ARR): The educated guess made by actuaries about how much they think they can earn by investing pension contributions. This is the most important assumption that pension boards determine to ensure benefits are fully funded.
Backloading: A retirement plan design where benefits are earned based on the years worked. The more years of service time, the more retirement income that is earned. For a pension plan with benefit multipliers that means the retirement income earned is exponential.
Beneficiary: A person designated by the terms of the pension plan that is, or may become, entitled to a benefit under the plan. Typically, these benefits are spousal benefits and survivorship benefits for minor children.
Benefit Formula: The formula used to calculate the pension benefit a teacher will receive upon retirement.
[Years of Service (x) Multiplier (x) Final Average Salary]
Cash balance plan: A kind of defined benefit retirement plan that provides income through an individual account with investments managed by the state and returns guaranteed at a minimum level.
Also see: guaranteed return plan.
Compounding Benefits: Retirement funds permanently adjust the base benefit and add any future changes to benefits on top.
Contributions: An amount of money paid into a retirement plan, typically from an employee (plan member), employer, or state legislature. Member contributions into any kind of retirement plan are typically refundable if that individual leaves and withdraws their money. Employer contributions to a pension plan or hybrid plan usually cannot be withdrawn. Contributions from an employer or the state into a defined contribution plan or guaranteed return plan usually can be withdrawn, based on a vesting schedule to have access to these funds.
Cost-of-living adjustment (COLA): An annual change to a pension benefit for retirees, usually pegged to some measure of the rate of inflation. Some COLA benefits have minimum adjustments, such as 1% or 2%. Some COLA benefits have maximum adjustments. Some are intended to match inflation, while others are based in part on inflation and in part on some other metric, such as investment returns.
Similar terminology: inflation protection
Deferred retirement option plan (DROP): A supplemental retirement benefit provided by some pension plans that allow you to start receiving retirement checks during the final few years you work. A typical DROP will require you to commit to retire within one to five years, during which time your retirement plan will start putting pension payments into an individual account. Upon completing the DROP period, you would receive a lump sum of those payments, usually with some minimum rate of return on those assets. The rules for DROPs can vary considerably, changing how risky they are to plan sponsors.
Defined Benefit Plan: See guaranteed income plan
Defined Contribution Plan (DC plan): A retirement plan design based on contributions from members and employers into an individual account, which is then usually invested through professionally designed and managed funds (401k’s or 403b’s). The total assets upon retirement can be used as income, lump sum cash, or a combination of both.
Discount rate: A tool in the process of estimating the value of promised pension benefits. Actuaries need to use an interest rate to “discount” the value of future pension payments back into today’s dollars for the purposes of determining accrued liabilities or determining the value of pension benefits earned in a given year. This rate theoretically should reflect expectations about the future value of money. Most plans use the assumed rate of return for the discount rate, leading to some interchangeable terminology.
Expected rate of return: This term is often used interchangeably with “assumed rate of return.” Technically, the expected rate of return refers to the middle of the possible investment returns for a given pension fund’s portfolio. Investment advisors forecast what the probability is for different rates of return based on a given portfolio (such as the mix of stocks and bonds). The 50th percentile—or 50% probability—in that forecast is formally known as the expected rate of return. Pension board trustees do not always choose the expected rate of return as the assumed rate of return, but they do use it as a guidepost.
Also See: assumed rate of return
Fiduciary net position: A technical definition from the Governmental Accounting Standards Board for the market value of assets. All retirement systems that want to comply with GASB reporting requirements are required to measure the real value of their assets, instead of the actuarial value.
Also see: assets, market value
Final Average Salary (FAS): A measure of compensation that your benefit will be based on. The average salary of the last three or five years of work (in most states). Some states use the three or five highest years of salary.
Similar terminology: highest average salary
Funded Ratio: A measurement of what percentage of necessary funds a pension has already saved. It compares the dollars in the pension fund to the value of promised lifetime income benefits. A funded status below 100% means the plan has not saved enough.
Similar terminology: funded status
Funded Status: A measurement of whether the pension’s “fund” has enough money saved away to pay all promised future benefits.
Similar terminology: funded ratio, unfunded liabilities
Funding Formula: The formula that represents how pension plans are funded.
[Benefits + Expenses = Contributions + Investment Returns]
Funding period: The anticipated number of years remaining until the pension fund reaches 100% funded. This term is typically used by pension funds where the legislature has assigned fixed contribution rates instead of paying actuarially determined contribution rates. Actuaries analyze how long, given the prescribed contributions, it will take for any unfunded liabilities to be amortized—as opposed to starting with a desired amortization method and determining the contributions necessary to meet that objective.
Governmental Accounting Standards Board (GASB): A private organization that recommends standards for governments to use in accounting and financial reporting. No state or local government is required by any federal law to follow GASB recommendations, though it is often best practice to treat GASB standards as a minimum for accounting and operational purposes.
Guaranteed Income Plan (GI plan): A retirement plan that provides a fixed, guaranteed monthly income based on two factors: years worked and average salary during final working years. A broad term that can refer to more than just pension plans. This term is often used to refer to pensions, but technically it can refer to a range of retirement plan designs.
Similar terminology: pensions or defined benefit plans
Guaranteed Return Plan (GR plan): A retirement plan design that guarantees a minimum level of investment returns on contributions from members and employers, and usually shares large returns between members and the retirement system. The investments are managed by a retirement system on behalf of members who each have their own individual account balance (contributions plus investment returns). Upon retirement, GR plans usually convert the accumulated account balance into guaranteed income, similar to annuities.
Similar terminology: money purchase plans or cash balance plans
Highest Average Salary: See final average salary.
Hybrid Plan: A retirement plan design that mixes some combination of pension plans, DC plans, and GR plans. A typical hybrid plan provides a small pension plan and a small DC plan together. Upon retirement, the incomes created by both elements of these plans are combined for a single source of retirement income.
Interest credit: For those who have guaranteed return plans, this is the amount of interest that gets added to your accumulated balance of contributions. When individuals leave a pension fund and request a refund of their contributions, some pension funds also provide small interest credits on that balance of assets.
Interest Rates: A percentage increase, typically the amount a lender charges for a loan. U.S. Treasury bonds are sometimes seen as risk-free interest rates because the yield is the amount the government is paying to borrow money, and there is virtually no risk that the government would default on its loan.
Investment Losses: When pension funds lose money due to underperforming investments not averaging out with investment gains over time.
Investment Returns: The measurement of how much a retirement fund’s assets have increased or decreased over a particular period of time. Another way to think about this is the profits or losses from investing contributions into a defined benefit fund.
Maturing Plan: When a retirement plan has more retirees receiving benefits than active members contributing. This is not a problem as long as the plan’s funded status is close to 100%.
Multiplier: A number that is multiplied by your years of service and final average salary, creating the amount you’ll receive as a benefit when you retire. This number is predetermined in state statutes and can vary by state and hire date. The higher the multiplier, the larger the benefit.
Similar terminology: “accrual rate,” “crediting rate,” or another term that basically means “percentage to multiply the years of service.”
Net pension liability (NPL): A technical definition from the Governmental Accounting Standards Board for pension funding shortfalls. All retirement systems that want to comply with GASB reporting requirements are required to measure their obligations as total pension liabilities, and their assets using a market value called fiduciary net position. The difference between these two accounting metrics is the net pension liability. For practical purposes, the NPL is the same as pension debt.
Also see: unfunded liability
Non-Compounding Benefits: This means that all inflation adjustments are based on the original pension benefit value. Each year benefits increase, you get to keep the adjustment from the previous year. But, the percentage increase is based on your original pension.
Normal Cost: The total amount of money that should be contributed each year to pay for the future benefits earned during that year. The normal cost “prefunds” or “pays in advance” for promised pension benefits.
Payroll: The total amount paid to employees that are participating in a retirement system. The costs and contribution rates of a pension plan are often expressed as a percentage of the total plan payroll.
Pension Debt: A non-technical way to think about “unfunded liabilities.”
See unfunded liabilities.
Pension Obligations: Total amount of promised pension benefits, counting up all expected pension checks for active members and retirees, and then reporting those in today’s dollars.
Pension System: An umbrella administrative organization that ensures benefits are paid, records kept, contributions collected, and investments managed. The terminology for retirement systems can vary from state to state, with different words and phrases often holding the same meaning. Sometimes multiple retirement systems are managed by an umbrella system or association. Within a specific pension plan there might be various “tiers” of benefits that provide different formulas and qualifications based on starting date or job classification. The various labels are all important for making distinctions within a specific state, but often the terminology is interchangeable from state to state.
Similar terminology: pension plan, pension tier
Pension Wealth: A way to think about the value of retirement benefits. In this context, pension wealth is the total of all of the pension benefit checks that you are expected to receive between retirement and when you pass away, with that total then reverse inflation adjusted to be reported in current dollars. So pension wealth is a measurement in the value of money today of all of the pension benefit checks that you might receive in the future.
Replacement Rate: The technical term for comparing the amount of income you’ll receive as a retiree to the income you make during your working years (e.g., If your pre-retirement income is $100,000 and your retirement income is $75,000, your replacement rate would be 75%).
Retirement Security: Financial experts define a secure retirement by comparing the amount of income you’ll receive as a retiree to the income you make during your working years - also known as the “replacement rate”. A replacement rate of 60% to 80% of the salary you were earning during your final working years is most commonly agreed upon as a secure retirement.
Service credit: A term for measuring qualifying time served towards earning a pension benefit.
Total pension liability: A technical definition from the Governmental Accounting Standards Board for the value of promised benefits. All retirement systems that want to comply with GASB reporting requirements are required to measure their pension obligations in a particular way that sometimes can be slightly different from AAL.
Also see: actuarial accrued liabilities
Underperforming Investments: Investments are considered “underperforming” when actual returns are lower than the assumed rate of return.
Unfunded Liabilities: The difference between the value of promised benefits and the assets available to pay those benefits. This is the shortfall in assets that should be in the pension fund to pay out all promised benefits.
Similar terminology: pension debt
Unfunded liability amortization payments: See amortization payments.
Valuation: An analysis of the financial condition of a pension plan on a regular basis. The valuation determines the financial position of the plan and the future contribution rates needed to ensure its long-term funding. The pension plan’s actuaries determine how much money the plan needs to pay pension benefits by using various assumptions concerning future events and behaviors.
Vesting: The minimum number of years a state or local employee needs to work in a state in order to be entitled to receive a pension benefit or the money their employer has contributed to their individual retirement account.
Years of Service (YOS): How many qualifying years you’ve worked for your employer within the pension plan.