Corporate Tax Cut? Profit Repatriation? Rising Interest Rates?
Will President Trump's anticipated economic changes create opportunities for DB plans?
There is much debate in corporate boardrooms over the effect the current administration's economic policies will have on corporate tax rates, possible repatriation of foreign profits and interest rates. Considering all the talk about the changing economic environment, PLANSPONSOR sat down with Russ Proctor and Marty Menin of the Retirement Solutions Division at Pacific Life to ask them whether these developments will help defined benefit (DB) pension plans.
PLANSPONSOR: If corporate tax rates are reduced significantly this year or next, how could this impact pension plan sponsors?
Russ Proctor: Under the assumption that corporate tax rates will get reduced, plan sponsors might consider accelerating the funding of their pension plans to take advantage of the larger tax deduction before the lower tax rates are fully effective. In some cases, the contribution could be made after the end of the plan year and still deducted for that year. For example, a company with a calendar year plan year may be able to make a contribution as late as September 15 of the following year and deduct it for the prior year's tax return. If a plan sponsor intends to make a contribution to the pension plan in one of the next few years, it may make sense to do that in a year when it can take a larger tax deduction.
PS: What if the new administration gives companies a tax break on their offshore profits? Could they use those repatriated profits to make pension contributions?
Marty Menin: There are many reasons a plan sponsor may want to contribute available cash to its underfunded defined benefit plan. These include the potentially larger tax deduction we just mentioned, as well as reducing PBGC [Pension Benefit Guarantee Corporation] variable rate premiums. This year, the PBGC premium is 3.4% of the unfunded pension liability. Assuming average wages increase 3% per year, it is projected to increase to 3.9% in 2018 and 4.4% in 2019 (1). If the plan sponsor can make a contribution to fully fund the plan, it can reduce the impact of those large and increasing variable rate premiums. Some companies are considering "borrowing to fund." If you can borrow at an interest rate that is close to the PBGC variable premium rate, why not borrow the money and increase the funded status of the plan? So, whether a company has cash available, borrows the funds, or captures the funds thanks to a foreign profit repatriation program, it should review their options to deploy that cash, and that analysis may include the possibility of fully funding the pension plan.
PS: What would a plan sponsor do then? Terminate the pension plan? If suddenly you've made a huge contribution to your pension plan, what's next?
Menin: That's the key question: Once you've got a fully funded pension plan, what do you do then? Unfortunately, unless you've already filed for a plan termination, and filed all the necessary paperwork with the PBGC and the IRS [Internal Revenue Service], you can't immediately terminate the plan and get that liability off your balance sheet. A plan termination can take six to 18 months or longer. So, that's why we've built insurance options that offer flexibility for plan sponsors. There are tools that can help them lock in their funded status while they proceed with their plan termination.