Funding reserve contributions
How a board turns a reserve study into an actual dollar amount to collect each year.
A board sets its annual reserve contribution by picking a funding objective, baseline, threshold, or full, from its reserve study, then follows that objective's recommended yearly amount. Full funding, keeping the reserve near 100 percent of its calculated value, typically costs only 10 to 15 percent more per year than bare minimum baseline funding.
Three funding objectives, one board decision
A reserve study does not hand a board a single required number. It offers a choice of funding objective, and the board picks which one its annual contribution will target.
Baseline funding keeps the reserve cash balance above zero. It is the cheapest option, but it carries "little or no margin for error" and a high risk of special assessments. Threshold funding aims for a chosen dollar or percent floor somewhere in the middle. Full funding aims to keep the reserve balance equal to the calculated value of the association's deterioration, roughly 100 percent funded.
"Full Funding is a conservative alternative, where the objective in any year is to have a Reserve balance equal to the value of deterioration at the association."
Source: What is Full Funding and Baseline Funding?, Association Reserves, Inc.
The gap between the cheapest and safest option is smaller than boards expect. Full funding contributions are typically only 10 to 15 percent higher than baseline contributions, according to Association Reserves, which is a modest premium for a much smaller risk of a future special assessment.
What actually sets the dollar figure
Once a board picks an objective, the specific contribution number comes from two assumptions built into the study: an assumed interest rate and an assumed inflation rate. Interest is earned only on the money already sitting in the account. Inflation raises the future replacement cost of every component the reserve will eventually pay for.
"Inflation has a much greater impact on the funding plan."
Source: What's Included in a Reserve Study? Key Elements Explained, Reserve Advisors
A study that does not state its interest and inflation assumptions cannot be checked by the board approving it. Before adopting a contribution figure, ask the preparer what rates they used and why, rather than accepting the number as given.
Funding below the study is a legal decision, not just a budget one
A board is not automatically breaking the law by contributing less than its study recommends, but it is choosing the riskier end of a spectrum. Following an informed, documented reserve study is generally what earns a board's funding decision protection under the business judgment rule, which shields a decision made in good faith by a board that was disinterested, reasonably informed, and reasonably believed the decision served the association.
"Could very well face a future legal challenge to that decision."
Source: Is Reserve Funding Mandatory?, Berding Weil
California's own statute is read by one law firm as requiring assessments "sufficient to perform its obligations," leaving little room for a board to simply choose not to fund. Other states set a different standard, or none at all. Check your state's common interest ownership statute, and your own governing documents, for the rule that actually applies to your board.
If your board is already behind, a catch-up funding plan, raising contributions over time, is the standard way back, rather than waiting for a shortfall to force a special assessment.
Check yourself
Answer before you read the explanation, recalling it is what makes it stick.
A reserve study recommends full funding. The board approves half that amount with no discussion in the minutes. What does this do to the board's legal position?
A board is deciding between baseline funding and full funding for next year's budget. What is the practical tradeoff?
The reserve study's funding plan assumes a specific inflation rate and interest rate, but the report never explains where those numbers came from. What should the board do before approving it?
Sources
- What is Full Funding and Baseline Funding?, Association Reserves, Inc.
- What's Included in a Reserve Study? Key Elements Explained, Reserve Advisors
- Is Reserve Funding Mandatory?, Berding Weil
- Fiduciary Duties 101, Limiting the Liability of the Board, communityassociations.law
Reserves
Next, see how percent funded turns this year's contribution into a number you can track over time.
Whether your state sets any legal floor for reserve contributions, and how strictly it is enforced, varies by state and by your own governing documents.