Compliance November 10, 2017

NQDC, 457 Plans Included Among Senate Tax Reform Targets

Among other changes of note for plan sponsors, the proposal “applies a single aggregate limit to contributions for an employee in a governmental section 457(b) plan and elective deferrals for the same employee under a section 401(k) plan or a 403(b) plan of the same employer.”

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Finance Committee Chairman Orrin Hatch (R-Utah) makes what is a very important procedural point about the newly published tax reform overhaul proposal released by Senate GOP leadership: “This is just the start of the legislative process in the Senate.”

There will be, Hatch pledges, a robust committee debate on all the policies in the bill. And unlike with the failed health care reform effort, there will be an open amendment process, he claims. Hatch says he hopes to report “actual legislation” by the end of next week. 

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To clarify, the Senate Finance Committee traditionally first offers conceptual markups of its work, meaning its legislation is “debated and examined as a detailed narrative, rather than actual bill text,” Hatch explains. The proposal released today is a conceptual mark. Hatch says the committee will begin to debate and amend the legislative proposal on Monday, November 13. 

Business people, lobbyists and analysts from all industries—not to mention everyday citizens of all political persuasions—have eagerly awaited the Senate’s proposal for tax reform. As they have waited, members of the House Ways and Means Committee have already set about debating and amending their initial version of the Tax Cuts and Jobs Act. So far most of the amendments in the House are rather technical in nature and do not necessarily impact the substance of the tax bill as it pertains to retirement plans—but this could easily change in the weeks ahead. 

In a summary of amendments provided by House Ways and Means Chairman Kevin Brady (R-Texas), none seem to mention retirement plans directly. One potentially important amendment for the PLANSPONSOR readership “provides that certain employees who receive stock options or restricted stock units as compensation for the performance of services and later exercise such options or units may elect to defer recognition of income for up to five years, if the corporation’s stock is not publicly traded.”

Hatch highlights some key details in the newly emerged sister Senate proposal: “It nearly doubles the standard deduction to reduce or eliminate the federal income tax burden for tens of millions of American families. The standard deduction will increase from $6,350 to $12,000 for individuals and from $12,700 to $24,000 for married couples. For single parents, the standard deduction will increase from $9,300 to $18,000.”

Turning specifically to retirement planning issues, the tax draft maintains “conformity of contribution limits.” However, as detailed below, it also applies a 10% early withdrawal tax to governmental section 457(b) plans and proposes elimination of catch-up contributions for “high-wage employees,” those making more than $500,000 per year. 

Many retirement plan changes are called for 

Readers should note the proposal “applies a single aggregate limit to contributions for an employee in a governmental section 457(b) plan and elective deferrals for the same employee under a section 401(k) plan or a 403(b) plan of the same employer. Thus, the limit for governmental section 457(b) plans is coordinated with the limit for section 401(k) and 403(b) plans in the same manner as the limits are coordinated under present law for elective deferrals to section 401(k) and section 403(b) plans.”

Related to this, the proposal repeals the special rules allowing additional elective deferrals and catch-up contributions under section 403(b) plans and governmental section 457(b) plans. Thus, the same limits apply to elective deferrals and catch-up contributions under section 401(k) plans, section 403(b) plans and governmental section 457(b) plans. The proposal repeals the special rule allowing employer contributions to section 403(b) plans for up to five years after termination of employment.

The proposal also revises application of the limit on aggregate contributions to a qualified defined contribution plan or a section 403(b) plan—that is, the lesser of $54,000 and the employee’s compensation. As revised, a single aggregate limit applies to contributions for an employee to any defined contribution plans, any section 403(b) plans, and any governmental section 457(b) plans maintained by the same employer, including any members of a controlled group or affiliated service group.

There are further changes proposed to the treatment of qualified and non-qualified deferred compensation arrangements, some of them similar to what has been proposed in the House. Under the Senate proposal, “any compensation deferred under a nonqualified deferred compensation plan is includible in the gross income of the service provider when there is no substantial risk of forfeiture of the service provider’s rights to such compensation.”

For this purpose, the rights of a service provider to compensation are treated as subject to a substantial risk of forfeiture “only if the rights are conditioned on the future performance of substantial services by any individual. Under the proposal, a condition related to a purpose of the compensation other than the future performance of substantial services (such as a condition based on achieving a specified performance goal or a condition intended in whole or in part to defer taxation) does not create a substantial risk of forfeiture, regardless of whether the possibility of forfeiture is substantial.”

In addition, “a covenant not to compete does not create a substantial risk of forfeiture.” The proposal applies “without regard to the method of accounting of the service provider.” Because of the definition of substantial risk of forfeiture under the proposal, “a taxpayer using either the cash method of accounting or the accrual method of accounting may be required to include deferred compensation in income earlier than the method of accounting would otherwise require.”

Administration November 10, 2017

Reports of Pension Funded Status for October Are Mixed

Those tracking S&P plans estimate a slight decrease in or flat pension funding ratio, while other estimate a slight increase. Most agree funding is up for the year.

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The S&P 500 aggregate pension funded status decreased slightly in the month of October from 81.8% to 81.7%, according to Aon Hewitt.

Pension asset returns were positive throughout the month, ending with a 1.1 % return. However, the month-end 10-year Treasury rate increased by 5 bps relative to the September month-end rate while credit spreads narrowed by 12 bps. This combination resulted in a decrease in the interest rates used to value pension liabilities from 3.57% to 3.50%. Given a majority of the plans in the U.S. are still exposed to interest rate risk, the increase in pension liability caused by decreasing interest rates counteracted the positive effects from asset returns on the funded status of the plan.

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The estimated aggregate funding status of pension plans sponsored by S&P 1500 companies remained level at 83% in October, as a result of a decrease in discount rates offset by positive equity markets, according to Mercer.

As of October 31, the estimated aggregate deficit of $387 billion represents a decrease of $5 billion as compared to the deficit measured at the end of September 2017. The aggregate deficit is down $21 billion from the $408 billion measured at the end of 2016.

The S&P 500 index gained 2.22% and the MSCI EAFE index gained 1.46% in October. Typical discount rates for pension plans as measured by the Mercer Yield Curve decreased by 4 basis points to 3.67%.

“While equities performed well, discount rates continue to stay near lows for the year,” says Scott Jarboe, a partner in Mercer’s Wealth business. “With equity markets at all-time highs, and with the potential for tax reform moving to the top of the political agenda, we are encouraging sponsors to take a fresh look at their pension journey.  With the potential for tax reform, we think many sponsors will consider accelerating contributions this year, which has dynamic implications on investment de-risking and risk transfer.” 

Northern Trust Asset Management reports that during the month of October, pension plans generally experienced a modest improvement as the average funded ratio increased from 82.9% to 83.0%, driven by two primary factors: Asset returns were strong as global equity markets returned over 2%; and the average discount rate decreased modestly from 3.72% to 3.69% during the month. Lower discount rates lead to higher liabilities.

The aggregate funded ratio for U.S. corporate pension plans increased by 0.4 percentage points to end the month of October at 84.7%, up 7.4 percentage points over the trailing twelve months, according to Wilshire Consulting.

The monthly change in funding resulted from a 0.9% increase in asset values partially offset by a 0.5% increase in liability values.  The aggregate funded ratio was up 3.8 percentage points year-to-date.

Legal & General Investment Management Americas (LGIMA) estimates pension funding ratios increased 0.3% over the month of October, driven primarily by gains in the equity market. LGIMA estimates Treasury rates increased 2 basis points while credit spreads tightened 7 basis points, resulting in the discount rate falling 5 basis points. Overall, liabilities for the average plan were up 0.98%, while plan assets with a traditional “60/40” asset allocation increased by 1.28%.

October Three says the big story for pension sponsors in 2017 so far is the remarkably steady increases in stocks, which have gained ground every month this year, overcoming interest rates that continue to flirt with historic lows. October saw a continuation of this pattern, improving the funded status for both model plans October Three tracks. Traditional Plan A improved 1% last month and is now up more than 4% for the year, while the more conservative Plan B improved a fraction of 1% in October and is now ahead 1% to 2% through the first ten months of 2017.

Plan A is a traditional plan (duration 12 at 5.5%) with a 60/40 asset allocation, while Plan B is a cash balance plan (duration 9 at 5.5%) with a 20/80 allocation with a greater emphasis on corporate and long-duration bonds.

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