A pension's discount rate is the interest rate used to convert future benefit payments into a single present-value liability today. Higher discount rates produce smaller reported liabilities and stronger funded status; lower rates inflate liabilities. Under US accounting (ASC 715), the rate is set from high-quality corporate bond yields, so when those yields rose after 2022, corporate pension liabilities shrank and funded ratios climbed above 100%.
No single number matters more to a defined benefit pension plan than the discount rate. It does not change a single dollar the plan will actually pay a retiree, yet it can swing the plan's reported liability by hundreds of billions and flip a plan from deficit to surplus overnight. Understanding it is the difference between reading a pension balance sheet and being misled by one.
What the discount rate actually does
A pension plan is a promise to make payments far into the future — sometimes 40 or 50 years out. To put a value on that promise today, actuaries calculate its present value: what one lump sum, invested now, would need to be worth to cover all those future payments as they fall due. The interest rate used in that calculation is the discount rate.
The mechanics are pure compounding in reverse. A dollar owed in the future is worth less than a dollar today, and the higher the discount rate, the less it is worth. Discount a payment of $100 due in 20 years at 3% and its present value is about $55; discount the same $100 at 5% and it falls to about $37. The promise has not changed — only the rate used to value it.
Multiply that effect across millions of benefit payments stretching over decades and small moves in the discount rate produce enormous moves in the headline liability. This is why pension finance can feel counterintuitive: a plan can report a dramatically smaller liability without paying out a cent less.
Why higher rates shrank pension liabilities
For most of the 2010s and into the early 2020s, ultra-low interest rates were the defining problem of corporate pension finance. With high-quality bond yields below 3%, the discount rate was low, present values were high, and reported liabilities ballooned. Many plans were chronically underfunded not because their investments did badly but because the arithmetic of low rates inflated what they owed.
The regime changed sharply after 2022. As central banks raised rates and corporate bond yields rose, pension discount rates climbed with them. Milliman's index of large US corporate plans recorded a discount rate of roughly 5.3-5.5% at the turn of 2025-26, up from the sub-3% world of a few years earlier. That single shift compressed liabilities across the corporate universe and, combined with solid asset returns, pushed funded status into surplus — the Milliman 100 funded ratio improved from about 103% to 109% over the twelve months to early 2026.
The lesson for any allocator: a large share of the "pension crisis" of the 2010s and the "pension recovery" of the mid-2020s was driven not by investment skill but by where bond yields happened to sit.
How the discount rate is set: ASC 715 versus public plans
Where the rate comes from depends on which rulebook applies, and the differences are not academic.
Under ASC 715, the US accounting standard for corporate plans, the discount rate must reflect market yields on high-quality fixed-income instruments — typically AA-rated corporate bonds — whose cash flows are matched to the timing of the plan's expected benefit payments. The objective, in the standard's own language, is to find the rate at which a portfolio of high-quality debt could settle the obligations as they come due. Crucially, this rate has nothing to do with how the plan's assets are actually invested.
Many US public plans, governed by GASB rules, take a different route: they discount liabilities using their assumed long-term return on assets, often 6.5-7%. Because that assumed return is usually higher than corporate bond yields, public plans report smaller liabilities for an economically similar promise. Economists have long criticised this as understating the true cost, since the discount rate should reflect the riskiness of the liability, not the hoped-for return on the assets backing it.
The practical consequence: a corporate plan and a public plan can owe identical benefits and report very different funded ratios, purely because of the rate each is permitted to use.
Why one plan reports several liabilities
It is entirely normal for a single pension plan to disclose more than one funded status, and the discount rate is usually the reason. The accounting liability (ASC 715) uses high-quality bond yields. The funding liability under ERISA and IRS rules uses prescribed corporate-bond rate segments, often smoothed over time. The settlement or buyout liability — what an insurer would charge to take the plan off the sponsor's hands — reflects the insurer's own pricing and is typically the largest of the three.
None of these is "wrong." They answer different questions: what the cost looks like for financial reporting, what the sponsor must contribute, and what it would take to discharge the obligation entirely. An allocator reading a pension disclosure should always ask which liability is being quoted before drawing conclusions about a plan's health.
What this means for asset owners and their counterparties
For pension investment teams, the discount rate is the reason liability-driven investing exists. If liabilities move with bond yields, holding long-duration bonds that move the same way hedges the funded ratio against rate swings. The discount rate is, in effect, the benchmark a hedging portfolio is built to track.
For asset managers, insurers and advisers selling to pension plans, the rate environment shapes the entire conversation. A higher-rate world full of newly-funded plans is one where pension risk transfer — buyouts and buy-ins by insurers — becomes attractive, because a plan in surplus can afford to lock in its position. The wave of corporate de-risking in the mid-2020s is a direct downstream effect of where discount rates sat.
In plain English
The discount rate is the interest rate a pension uses to figure out how much money it needs today to cover what it owes tomorrow. When that rate is high, future promises look cheap and the plan looks well funded; when it is low, the same promises look expensive and the plan looks underfunded. Nothing about the actual pensions changes — only the maths used to value them. That is why the discount rate, more than any market move, deserves the first question when you read a pension's balance sheet.
Sources and further reading
- Milliman, Pension Funding Index (2025-2026) and 2026 Corporate Pension Funding Study — discount rate ~5.3-5.5%, funded ratio ~109%.
- PwC, Pensions and Employee Benefits Guide §2.4 — ASC 715 financial assumptions and discount rate selection.
- SEI, "Pension accounting: ASC 715 discount rate selection."
- FASB ASC 715-30-35-43/44 — objective of the assumed discount rate.