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Amortization Payments

When a pension fund has a shortfall, contributions are necessary to catch up on the appropriate amount of funding. These contributions are known as amortization payments.

Pension funds should pay off their debt as quickly as possible, so that the debt doesn’t grow—and so the fund doesn’t risk running out of cash. Since investment returns can’t be assured, that means increasing total contributions to balance the ledger.

Similar to paying off a mortgage or credit card, the longer pension funds take to pay off debt, the more interest will add up, and the more contributions will have to go up to pay for it.

In some places, legislatures provide a fixed amount of contributions to pension plans, ignoring what actuaries determine is necessary to fully fund benefits. In these cases, actuaries determine how many years it will take for that amount given every year to eliminate unfunded liabilities and report that number. In others, 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

The process of determining whether amortization payments will be made over a fixed period of time, or annually refinanced, is known as the “amortization method.” This is akin to paying off credit card debt over the course of a year versus only making the minimum monthly payment and allowing the balance to grow unchecked.

Resetting amortization payments is an accounting method designed to keep annual costs low in the near-term, but it makes the total amount of pension debt larger in the long run. Indefinite amortization periods—like only making the minimum payment on a credit card—are good for near-term budget management and terrible for long-term cost stability.

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