Picture yourself in this scenario: The clubhouse needs a new water heater and it will cost $10,000. But all prior reserve studies that have been done in the association have only allocated $6,000 for replacement. What are the board’s options to make up the additional $4,000 difference?
In other words, if an item listed as a reserve fund component needs replacement and the bids come in significantly higher than the amount that has been listed and saved for, can the board take all the funds out of the reserves? Or do they need to do a special assessment for the difference between the costs versus the bids?
Reserve work is usually done on a threshold funding plan. The idea is that you don't fall below a certain level of either money or a percent of funding. You contribute money to a big overall pot and it's there to pay for various components in the association when they need to be replaced.
The Basics of How the Reserve Fund is Used
Reserve money goes into a big pot. You don't allocate it for specific components, such as water heaters here, painting there – they're not in separate buckets. Instead you're doing a best guess for different components. Since it's going to be spent at various times, you're not always going to have exact amounts for individual items, but the money is still in one big pot.
So, let’s say you have $200,000 in your reserve planned for items that are three, four or five years out. The water heater, as mentioned above, may cost $4,000 more than planned for, but another item may cost less or may not need to be repaired or replaced for a few years, so it’s okay to spend the money needed now for the water heater.
The Importance of Adjusting the Reserve Budget
The reason you can do this is because the reserve study is adjusted for reality at the end of the year, and then the funding plan adjusts accordingly as well. Of course, it’s crucial that your board and HOA manager look at the reserve study and reserve fund during budget time each year to make sure it’s adjusted accordingly.
When Adequate Reserve Funds Aren't There
It’s important to note that if the association’s reserve fund is at a point where replacing or repairing a component is going to take all the money out of the reserves and deplete your resources completely then there’s a problem. The reserve study is inaccurate, the reserves are underfunded, or the plan wasn’t adjusted like it should have been somewhere along the line. A special assessment or another alternative solution may be needed.
Reserve funding can be a confusing issue, especially if you don’t have an accounting background or just aren’t a numbers person. Just remember the way to look at the reserve fund is as one big pot, not small buckets; to update your reserve study each year (and adjust the reserve budget accordingly!) and to work with experienced professionals, such as a reserve specialist, financial adviser or HOA manager.