Discuss Accelerating Contributions With DB Plan Sponsor Clients
Contributing more than the minimum required for 2017 by the September 15 deadline will result in a higher deduction for plan sponsors, and continuing to accelerate funding in the future can minimize PBGC costs, improve funded status and mitigate higher required contributions in coming years.
Defined benefit (DB) plan sponsors have until September 15 to make a contribution to their plans that will be treated as a 2017 plan contribution.
This is especially important this year, as the corporate tax rate under the Tax Cuts and Jobs Act will change from 35% to 21%. This means contributions toward 2017 made by September 15 will be subject to a greater deduction for DB plan sponsors.
“When the tax bill was signed, we immediately recognized an historic opportunity for pension sponsors that are also corporate taxpayers. Under prior law, the after-tax cost of a $1 million pension contribution was $650,000 (based on a 35% corporate tax rate). Under the new law (21% corporate tax rate), the after-tax cost is $790,000. With the stroke of a pen, the cost of financing pensions for taxable corporations increases 21.5% starting in 2018,” explains Brian Donohue, partner/actuary, October Three Consulting, based in Chicago.
Alexa Nerdrum, managing director, retirement at Willis Towers Watson, based in the Detroit office, says a lot of companies have already thought through this issue since they’ve known about it for some time. She says Willis Towers Watson is not seeing companies borrow to fund; they are either in a position from a cash standpoint to make a higher contribution than the minimum allowed, or they do nothing.
“We expect a flurry of activity in the next couple weeks. In all likelihood, 2018 will break all the records for U.S. private-sector pension funding,” Donohue says.
If plan sponsors decide to put available cash into their pension plans, they need to put it into the pension’s trust by September 15, Nerdrum says. “Formal documentation of this is part of Form 5500 filings. Schedule SB shows all contributions made and the dates they are made,” she explains.
Nerdrum notes that even before the tax legislation, plan sponsors were accelerating contributions to be in a better funded position and to minimize “ever-increasing” Pension Benefit Guaranty Corporation (PBGC) premiums. These will still be incentives to contribute more than the minimum required in the future.
“In my 31 years as a pension actuary, I have seen nothing related to pensions that produces such a meaningful financial impact on employers’ overall business operations,” Donohue states.
“As funding levels have improved, we have seen several actions in the market, such as pension risk transfer actions, including implementing lump-sum windows and annuity purchases for retirees,” she says. “We’ve also seen a shift in investment allocation from more of an equity-based mix to a fixed income-based mix to preserve funding.”
According to Nerdrum, DB plan sponsors will see an increase in minimum contribution requirements in coming years due to several factors, including the phase out of funding relief. “Tax reform has allowed plan sponsors to take advantage of a higher deduction. Doing so may mitigate the need for higher contributions in the future.”According to Donohue, sponsors of ongoing pension plans can use this opportunity to pre-fund several years’ worth of future retirement benefits, before the 21.5% cost increase kicks in.
He adds that sponsors of frozen plans may be concerned about contributing too much to their plans, creating an overfunded plan. “The general view is that surplus pension assets are of little value to employers, but, in reality, employers can typically make use of even quite large pension surpluses to finance future retirement benefits to employees. Exploring and understanding these strategies can affect employer decisions regarding large pension contributions this year,” he says.