Unfunded arrangement: Overview, definition, and example
What is an unfunded arrangement?
An unfunded arrangement is a benefit plan or financial obligation where no specific assets are set aside in advance to cover future payments. Instead, payments are made when they become due, typically from an employer’s general funds. These arrangements are common in deferred compensation plans, retirement benefits, and executive compensation structures.
For example, a company may promise to pay a retiring executive a certain amount each year for ten years, but instead of setting aside funds in a dedicated account, the company pays the benefits directly from its operating budget when the payments are due.
Why is an unfunded arrangement important?
Unfunded arrangements give businesses flexibility in managing cash flow since they don’t require immediate funding. However, they also come with risks—if the company faces financial difficulties, it may struggle to meet its obligations.
For employees and retirees, an unfunded arrangement means their benefits are not secured by a trust or separate fund. If the employer goes bankrupt, they may not receive the promised payments. This is why understanding whether a plan is funded or unfunded is crucial when evaluating retirement or deferred compensation benefits.
Understanding an unfunded arrangement through an example
Imagine a company offers a deferred compensation plan to senior executives. Under this plan, executives can defer part of their salary to be paid out after retirement. However, instead of placing these funds in a secure account, the company simply records the obligation and plans to pay from future earnings. This makes the plan an unfunded arrangement—executives rely on the company's ability to make future payments.
In another case, a small business promises to pay long-term employees a bonus upon retirement. Rather than setting aside money in a pension fund, the company plans to pay the bonus from its future profits. If the business underperforms, employees may not receive the full amount, demonstrating the risk of an unfunded arrangement.
An example of an unfunded arrangement clause
Here’s how an unfunded arrangement clause might appear in an agreement:
“All benefits under this Agreement shall be paid from the general assets of the Employer, and no separate fund or trust shall be established for this purpose. The Employee shall have no secured interest in any assets of the Employer.”
Conclusion
An unfunded arrangement is a financial commitment without dedicated assets set aside for future payments. While it provides flexibility for businesses, it poses risks for employees and beneficiaries if the company cannot meet its obligations.
This article contains general legal information and does not contain legal advice. Cobrief is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.