The recovery in financial markets last year helped bring significant improvement to the financial health of U.S. pension funds, potentially adding $180 billion to companies' balance sheets, a survey showed on Tuesday.

Mercer, a leading pension advice firm, said U.S. pension funds were 85 percent funded at the end of December compared with 75 percent a year earlier.

But it also warned that such funds are becoming increasingly reliant on equity markets, and thus are vulnerable to volatility.

In total, Mercer found that U.S. pension funds run by S&P 1500 companies had a deficit of $229 billion at the end of 2009 compared with their liabilities over 10 years. It was $409 billion at end-2008.

This will be welcome news for plan sponsors, Adrian Hartshorn, a member of Mercer's team that helps companies manage financial risk in their retirement programs, said in a note.

The improved funded status will add $180 billion to the balance sheets of U.S. companies, which, over time will improve earnings and reduce the need for future cash contributions.

The improvement in pension fund holdings came as many financial markets rebounded from the drubbing they had received in 2008. The S&P 500 U.S. stock index <.SPX>, for example, rose 23.45 percent last year compared with a loss of 38.49 percent a year earlier.

But this growth also points to the risks facing the pension funds Mercer said.

It said the funds had predominantly been investing in equities, which are both volatile and have a low correlation to changes in the value of liabilities facing the plans. Bonds, by contrast, can be used to hedge liabilities.

Bond yields, however, are currently low given a general lack of inflation and low official rates. For investors with long-term liabilities, this means not only that they may not be getting enough return but also that they are threatened by any large-scale retreat from fixed income if central banks start raising interest rates.

According to Mercer calculations, the last time U.S. pension funds were in surplus was in May 2008. They have since had 19 consecutive months of deficits as markets reacted to the financial crisis.

(Editing by Patrick Graham)