Pension Smoothing

In Detail

Pension smoothing is the practice of recognizing investment gains and losses gradually over a period of years (typically 5-7 years) rather than all at once. This reduces the year-to-year volatility in required employer contributions. After a year of strong returns, the full gain is not immediately recognized — instead, one-fifth or one-seventh is recognized each year. The same applies to investment losses.

While smoothing provides budget predictability for plan sponsors, it also delays the recognition of true financial conditions. After the 2008 financial crisis, many plans with smoothing continued to report relatively healthy funded status for years even though their actual asset values had dropped dramatically. Congress has occasionally passed legislation that temporarily expanded smoothing provisions for private-sector plans, effectively allowing employers to contribute less to their plans in the short term. Critics argue this amounts to kicking the can down the road, as deferred recognition of losses leads to larger unfunded liabilities over time.

PensionWatch uses the actuarial (smoothed) values reported by plans, but the funding ratio trend over three years helps reveal whether smoothing is masking a deteriorating financial position.