DB Plans Accelerating Contributions Due to Tax Reform

The Tax Cuts and Jobs Act is prompting corporations to contribute more to defined benefit (DB) plans before the 2017 tax year ends on October 15, 2018. By contributing early, corporations can take advantage of a larger tax benefit by expensing their contributions at a higher tax rate. For contributions made before mid-October, the tax rate is 35%. The new legislation lowers the corporate income tax to 21%.

Additionally, as DB plans see improving funding levels, more plans may explore derisking. Cerulli suggests that investment managers may want to consider offering liability-driven investing (LDI) services, or strategies that fit into a derisking portfolio.

Likewise, because of higher Pension Benefit Guarantee Corporation (PBGC) premiums in recent years, several pensions with underfunded liabilities increased contributions to avoid paying a higher penalty. Some corporations even took out loans to make contributions and avoid paying larger variable-rate premiums.

The new tax year begins after October 15, 2018. Plans will need to start paying a higher amount to comply, and the more they are underfunded, the higher the cost. Corporations can, therefore, reduce costs in the future by increasing contributions for the current tax year, thereby improving their pension plans’ funded statuses, Cerulli says.

Citing data from Willis Towers Watson, Cerulli notes that companies contributed $51 billion to their pension plans in 2017, up from $43 billion in 2016. Cerulli says the increase was due to the rise in PBGC premiums and growing interest in derisking strategies.

Additionally, the tax reform lowers repatriated foreign earnings from 35% to 15.5%. While companies may use this additional cash for debt reduction, share repurchases or mergers and acquisitions, Cerulli expects that they will also use it to increase contributions to DB plans. Moody’s Investors Services estimates that companies’ offshore cash holdings totaled $1.4 trillion as of the end of last year.