Phones are ringing off the hook at firms that help companies manage their benefit offerings, especially pension plans, after the Tax Cuts and Jobs Act gave companies new incentives to fund up plans.
With defined benefit pension plans trailing in popularity, the new tax law changes don’t do anything to bolster their appeal as a compensation incentive, says Melissa Moore, U.S. annuity placement leader at Mercer. But the changes do give companies reasons to consider funding up the plans they currently have on the books, whether those plans are active or frozen. Companies are already in the throes of considering other changes to executive compensation as a result of the change in tax law.
The lowering of the corporate tax rate from 35 percent to 21 percent means any contributions a company might make will be deductible at a lower rate in 2018 than in 2017. So a $100 contribution in 2017 wins a $35 deduction in 2017, but that same contribution in 2018 merits a deduction of only $21.
Pension funding rules give companies more than eight months into a calendar year to make contributions for a prior year. If they make contributions in the early months of 2018 toward their 2017 pension obligations, those contributions will be deductible at the 2017 tax rate, which ultimately makes the contribution less expensive. “That’s just free money,” says Moore. “There’s no reason to leave that on the table.”
Aggregate pension funding across the Standard & Poors 1500 inched two percentage points higher in 2017, but remained at a deficit of $375 billion for the year, according to Mercer. Strong equity performance helped drive better funding levels for the year, but decreasing discount rates worked against equity performance to soften the improvement potential. That suggests companies generally have underfunded obligations on the books that eventually will require some kind of contribution.
To the extent multinational companies will be affected by the international tax provisions of the recently enacted tax reform legislation, that might also produce some cash in the United States that companies could consider allocating to pension funding, says Moore. To the extent companies increase their funding of defined benefit plans, they’ll also reduce the premiums they pay to the Pension Benefit Guaranty Corp., which insures such plans.
“This opens a lot of doors from a pension risk management standpoint,” says Moore. “If you’re going to fund a plan, you should be thinking about what you are doing from a risk management perspective.” That might include more interest in strategies like liability-driven investing, says Moore, where companies seek investment strategies that are intended to match the pension obligation over time.