Terminal Funding

Example

“Instead of contributing to John's pension throughout his 30-year career, the company used terminal funding to purchase an immediate annuity for $400,000 when he retired.”

Memory Tip

Remember 'Terminal = At The End' - terminal funding happens at the terminal point of employment, not throughout the career.

Why It Matters

Terminal funding can provide cost certainty for employers and guaranteed income for retirees, but it may result in lower benefits if investment returns during the working years would have been higher than the insurance company's assumptions. It also shifts longevity and investment risks from the employer to the insurance provider, which can be beneficial for both parties depending on market conditions.

Common Misconception

Many people think terminal funding means the employee receives a lump sum payment, but typically the employer pays the lump sum to an insurance company that then provides regular pension payments to the retiree. Some also believe this method always results in lower benefits, when in reality it depends on investment performance, interest rates, and longevity compared to traditional funding methods.

In Practice

An employee earns a pension worth $2,000 per month for life starting at age 65. With terminal funding, instead of the employer contributing to a pension fund throughout the employee's career, the employer pays $350,000 to an insurance company at retirement. The insurance company then guarantees the $2,000 monthly payment for the retiree's lifetime. If the retiree lives 20 years, they'll receive $480,000 total, while the insurance company invested the $350,000 and managed longevity risk across many retirees.

Etymology

The term 'terminal' comes from the Latin 'terminus' meaning 'end' or 'boundary,' referring to the funding occurring at the end of employment rather than throughout the working years.

Common Misspellings

Related Terms

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