Benefits

DB Sponsors: Consider Accelerating Contributions For 2017 Plan Year Amid Tax Reform

While the Trump administration’s Tax Cuts and Jobs Act makes no direct changes to employer-sponsored defined benefit (DB) retirement plans’ minimum funding or maximum deductibility laws, it could create an additional incentive for DB sponsors to accelerate contributions attributable to the 2017 plan year, according to one DB plan strategist.

Defined benefit retirement plan

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Those that can benefit most from the tax-reform act are corporate DB plan sponsors seeking to maximize the tax effectiveness of their contributions to their plan, Justin Owens, director of client strategy and research at Russell Investments said in a January 3 blog post.

And DB plan sponsors should be aware that while the 2017 calendar year is behind us, they can still generally contribute for the 2017 plan year until September 15, 2108, assuming they operate on a calendar-year plan year, Owens reminded.

Attributed to 2017 Plan Year

“While pension contributions will continue to be tax-deductible in the coming years, the relative tax deduction could be higher if the contributions are attributed to the 2017 plan year (when a higher tax rate applied),” Owens said.

As an example, he presented a sponsoring company having $100 million in cash that it intends to contribute to the pension plan over the next few years, starting with 2018. Assuming a new, lowered 21% tax rate, this roughly would mean they could reduce their tax burden by $21 million over that time period—ignoring the effect of other deductions and discounting, the Russell Investments research director said.

But if the company accelerated those contributions to the plan to be attributable to 2017, under a 35% tax rate, then the reduction in tax could be $35 million, a $14 million tax savings. (Owens noted that many U.S. company tax rates were lower than 35% before the tax-cut legislation.) His example assumes all contributions still fall under the maximum deductible amount calculated by the plan’s actuary.

In addition, he said, if the $100 million contribution were used to reduce a vested funding deficit, as used for Pension Benefit Guaranty Corporation (PBGC) purposes, the sponsor could save nearly $4 million in PBGC premiums each year that the contributions are accelerated. Owens said this reduction only applies until the plan is fully funded on a vested liability basis and assumes the per-participant cap didn’t previously apply to it.

This kind of maneuver may be considered indirect or delayed savings, as many DB plan sponsors pay for PBGC premiums out of plan assets, Owens said.

Owens’ example is simplified, but he suggests DB plan sponsors be familiar with the math behind the decision-making process for accelerating contributions.

The 9-month period in 2018 during which corporate contributions are allowed for the 2017 plan year “gives sponsors some time to thoughtfully consider discretionary contribution options and their effects on overall plan strategy. For a taxable DB sponsor, this option is likely worth exploring,” Owens said in his blogpost.

He said that 2017 was a “banner year” for discretionary pension contributions by DB plan sponsors. But despite ongoing funding relief, he said, Russell Investments expects that single-employer DB plans will absorb the highest level of contributions since 2012, the year that the Moving Ahead for Progress in the 21st Century Act (MAP-21) was passed, legislation that included the easing of pension funding requirements (see DOL Helps Plans Find How MAP-21 Changed Liability Calculations).

Influence of Rising PBGC Premiums

A key motivator for many plans to increase contributions for the 2017 plan year has been rising PBGC variable-rate premiums, scheduled to increase through 2019 and beyond, when they are pegged to inflation. Paying just the minimum to an underfunded DB plan in the current PBGC premium-rate environment is an inefficient use of cash, Owens said.

However, discretionary contributions create a ripple effect for plans. Owens said improved funded status could lead to greater overall allocations to liability-hedging fixed income positions and higher hedge ratios. It also could boost the employer’s interest in “derisking” transactions, such as lump-sum offers and annuity purchases, which reduce pension benefit obligations on a company’s balance sheet.

Jane Meacham is the editor of BLR’s retirement plan compliance publications. She has nearly 30 years’ experience as a writer/editor of financial services news.