What is the purpose of asset smoothing in pension funding?

The purpose of asset smoothing in pension funding is to stabilize contributions over time. This approach helps pension plans manage the volatility associated with changes in investment returns and funding levels. By averaging investment gains and losses over a period, asset smoothing reduces the annual fluctuations in the required contributions from employers and employees. This stability is particularly important as it helps organizations plan their budgets more effectively and avoids drastic increases or decreases in funding requirements due to market conditions.

Moreover, stable contribution levels can enhance predictability for both the plan sponsors and the plan participants, fostering a more consistent approach to retirement funding and helping to ensure the long-term sustainability of the pension plan. In a well-structured pension plan, ensuring that contributions are stable helps align cash flows and fund management strategies, ultimately aiming for a well-funded retirement benefit for participants.