Pension plans are experiencing a pivotal moment. Many have reached or exceeded a 100 percent funded percentage, creating opportunities for potential benefit improvements while maintaining financial stability. At the same time, trustees are looking for strategies to reduce risk and ensure long-term sustainability.
This article explores how variable annuity pension plans (VAPPs) can help retirement plan sponsors achieve these goals while continuing to provide meaningful retirement income that’s stable and secure for retirement plan participants.
Overall funding levels for pension plans continue to improve.
For multiemployer plans, Segal’s latest Survey of Plans’ Zone Status found that as of January 1, 2026, more than three quarters of calendar-year plans are in the green zone, and the average funded percentage on a market-value basis is 111 percent, compared to 105 percent the prior year. With recent strong performance in the financial markets and contribution rates that generally exceed the cost of the benefit accruals, the percentage of plans that are well funded is expected to remain strong.
As pension plans approach and even exceed being 100 percent funded, trustees face competing desires: improving benefits (i.e., providing larger benefits) and reducing the plan’s expected rate of investment return.
During the Great Recession and the volatile period that followed, many plans were forced to make either large benefit cuts or large increases in employer contributions to maintain the prior benefit level.
Over the last few decades, the purchasing power of pensions has been greatly reduced. As plans have improved their funded percentages, there is great pressure from participants to close the gap and provide larger benefits in retirement to make up for years of no or limited benefit increases.
Meanwhile, the lessons learned from the market volatility in the early 2000s and 2008 still weigh heavily on trustees. (Our July 2026 survey report includes data from 19 years of zone-status certifications to provide perspective on changes over the long term, from strength to stress to recovery.)
Many boards of trustees are seeking ways to reduce risk and avoid future periods where benefits might be reduced. For multiemployer plans, pension contributions represent a large portion of the overall wage and benefit package, and the needs of associated health and welfare plans, annuity funds and wage pressures due to inflation may limit the amount of contributions available if another period of market losses occurs. These pressures are prompting increased interest in alternative plan designs, including VAPPs, which may help reduce exposure to market volatility over time.
VAPPs are pension plans designed to balance risk between promised benefit levels and the contributions needed to fund them. Like traditional defined benefits (DB) plans, they use a set formula, typically based on pension credits or contributions, to determine how benefits accrue. And like traditional DB plans, VAPPs provide lifetime income, offer early retirement options, disability benefits, death benefits and various benefit options in retirement.
The key difference between VAPPs and traditional pension plans, however, is that benefit accruals within a VAPP are not fixed as of the date they are earned. Instead, those benefits increase or decrease each year based on the plan’s investment returns compared to a “hurdle rate” determined by the plan, which is typically around 5 percent. In traditional DB plans, most risks are borne by the plan sponsor. However, if investments fall short of expectations, there is often pressure to lower benefits (prospectively only) or increase contributions. Under a VAPP, benefit levels and investments are more closely matched. When investment returns are below the hurdle rate, benefits automatically adjust downward to reflect the reduced returns.
Meanwhile, when the plan outperforms the hurdle rate, benefits automatically adjust upward to share the investment gains. Participants share the investment risk, reducing pressure on the plan design and contribution levels.
Because the VAPP benefit is provided as a lifetime annuity, the plan retains longevity risk; participants in these plans need not fear outliving their benefits.
Within a traditional DB plan, the options available to address investment underperformance are limited. Any benefit changes to save money are usually limited to future accruals for active participants. While many plans have half or more of their liabilities associated with benefits to non-active participants, any benefit changes to address unfunded liabilities are limited to the active participant population. Contribution increases are no different: because contributions are only made on behalf of future active participants, any losses to the plan associated with retiree liabilities are spread across everyone who’s still working.
A VAPP works differently. Because all benefits float with investment returns, the impact of investment losses are spread out over the benefits those investments support. Retirees and other non-active participants bear the risk — and reap the rewards. Unlike a traditional defined benefit plan where the younger active participants take the lion’s share of responsibility for everyone’s risks, a VAPP can spread those risks across participants more evenly.
Benefits in a VAPP are earned just like in a traditional defined benefit plan, usually either as a percentage of contributions made on a participant’s behalf, or a set dollar amount per pension credit earned. Unlike a traditional plan, the VAPP accrued benefit is then adjusted each year based on asset returns versus the plan’s hurdle rate. Because investment returns are usually expected to exceed the hurdle rate, benefits are expected to increase each year into the future, on average, and are therefore more valuable than benefits provided within a traditional DB plan.
One of the most compelling features of VAPPs from a plan design perspective is the potential for benefits to increase during retirement, similar to cost-of-living adjustments. Just like benefit accruals for active participants, the monthly benefit to retirees and beneficiaries earned in the variable formula can continue to fluctuate, even in retirement.
When investment returns exceed the hurdle rate, retirees see their benefits grow, helping them keep pace with inflation.
Under a “pure” VAPP, benefits adjust each year based on investment returns, including in retirement. In this design, retirees and beneficiaries will occasionally see decreases in their benefit levels when investment returns fall short of the hurdle rate. The expected frequency and severity of benefit decreases often serve as a barrier to trustees adopting a variable annuity design. However, there are ways to reduce or potentially eliminate those benefit decreases.
Many plans offering VAPPs have adopted reserve accounts to protect against benefit decreases in retirement. Reserves are funded through dedicated contributions or by allocating a portion of investment returns over the hurdle rate. When investment returns would otherwise result in a decrease in benefits for retirees, reserves are spent to stabilize the benefit, either at the current level, or some other level chosen by the trustees. Reserves can also be used to stabilize benefits for participants who are close to retirement or provide benefit increases.
Alternatively, some plans “smooth” investment returns when measuring performance against the hurdle rate. Instead of using single-year market returns (which are often volatile), plans can use a more predictable three- or five-year average return. These average returns are more stable, resulting in more predictable upward adjustments and fewer (and less severe) downward adjustments than those calculated using single-year returns.
As plans approach or exceed 100 percent funding, trustees have the option to maintain current accrual rates and further mitigate future risks if transitioning to a variable formula. This can effectively reallocate contributions that had previously been used to reduce unfunded liability to support future benefit accruals, while providing those future accruals with significantly less risk to the plan.
Pension plans that embrace VAPP designs can offer meaningful retirement income, stabilize contribution requirements and ensure future benefit payments are secure. By designing plans that serve all stakeholders, plan sponsors can position the plan for long-term success.
This page is for informational purposes only and does not constitute legal, tax or investment advice. You are encouraged to discuss the issues raised here with your legal, tax and other advisors before determining how the issues apply to your specific situations.