Provisions of Tax Reform Could Affect DB Plan
Sponsor Strategies By Rebecca Moore January 8, 2018
DB plan sponsors may want to make a voluntary
contribution to their plans in 2018 to claim a deduction at their
former, higher tax rate, according to Michael A. Moran, with
GSAM.
Since,
under tax reform, the corporate tax rate will be lower in the
future than what had previously been in effect, more voluntary
defined benefit (DB) plan contribution activity is expected,
according to Michael A. Moran, CFA, managing director and chief
pension strategist with Goldman Sachs Asset Management (GSAM).
In a Q&A on GSAM’s website, Moran explains that
contributions to corporate DB plans are generally tax deductible
up to certain limits. For plan sponsors that were contemplating
making a contribution in future years, some decided to accelerate
that contribution into 2017 in order to reap the benefits of
getting the tax deduction at a higher rate. GSAM observed that
Kroger and Valvoline are two examples of companies that
explicitly cited potential corporate tax reform as one of the
reasons for making a voluntary contribution earlier in 2017.
According
to Moran, since plan sponsors can under certain circumstances
make a contribution up to eight and one-half months after the end
of the year and still have it count as a deduction for the
previous tax year, the firm expects voluntary contribution
activity to continue into 2018 where sponsors claim a deduction
at their former, higher tax rate.
In
addition, changes to repatriation rules under tax reform may make
foreign cash more accessible for U.S. multi-nationals, which may
enable them to continue to make voluntary contributions in the
future. Moran says estimates of overseas cash for U.S.
companies have been in the range of $1 to $2.5 trillion.
He points
out there have been several other factors which have also
provided plan sponsors with an incentive to put more money into
their plans sooner rather than later, including Pension Benefit Guaranty
Corporation (PBGC) premiums.
Increased
contribution activity leads to higher funded ratios which may be
a catalyst for more de-risking activities, according to Moran.
This may take the form of increased allocations to long duration
fixed income, to better match plan liabilities, as well as more
risk transfer activities since better funded plans make it easier
for the plan sponsor to transfer liabilities to a third-party
insurance company. Click
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IRS Memo on RMDs
Includes Standards for Searching for Missing Participants Seyfarth Shaw, LLP
11/02/2017 Attorneys: Jake R. Downing, Michael Weisshar, Randell Montellaro, Fredric S. Singerman
Seyfarth Synopsis: The Internal Revenue Service
released guidance detailing specific procedures qualified
retirement plans may utilize to satisfy required minimum
distribution standards for missing participants and
beneficiaries.
Internal
Revenue Code section 401(a)(9) establishes required minimum
distribution (“RMD”) standards for qualified retirement plans.
Generally, these standards require a participant’s benefit
payments to begin no later than April 1 of the calendar year
after the participant attains the age 70½ or retires. In the case
of a deceased participant, RMD payments must generally be made to
a non-spouse beneficiary within five calendar years after the
year of the participant’s death. The Internal Revenue Service
(“IRS”) has released administrative guidance regarding how
qualified retirement plans may satisfy RMD standards when the
participant or beneficiary to whom the payment is due cannot be
located.
A
qualified retirement plan that cannot locate a participant or
beneficiary will be treated as satisfying RMD standards if the
plan: (1) searches plan and publicly available records for the
participant’s contact information; (2) uses a commercial locator
service, credit reporting agency or proprietary internet search
tool to locate the participant or beneficiary; and (3) attempts
to contact the participant or beneficiary via United States
Postal Service certified mail to the last known mailing address
and any other appropriate means of contact, such as by email or
telephone.
Implications for Employers
Prior to
this guidance, qualified retirement plans that did not make RMDs
to missing participants or beneficiaries risked being considered
in violation of the RMD requirements, and different IRS regions
could apply different standards on audit. Now, qualified
retirement plans that cannot locate a participant or beneficiary
will be treated as not violating the RMD standards if in compliance
with the procedures above.
Although
this new guidance is very helpful to plan sponsors, note that the
Department of Labor (“DOL”) also audits retirement plans to
assure that a plan maintains a prudent process for locating
participants and paying benefits. The IRS’s guidance does not
necessarily reflect what efforts the DOL may require a plan to
make to locate lost participants. Click
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DB Plan Sponsors Should Balance Four Levers to
Improve Funding By Rebecca Moore
No lever alone is enough to close the pension
funding gap, according to a report from Cambridge Associates.
Even amid
a surging bull equity market, the average funded status of U.S.
defined benefit (DB) plans has risen by only 2% in the last eight
years, from 79% to 81%, according to global investment firm
Cambridge Associates.
In a
report, “A Balancing Act: Strategies for Financial
Executives in Managing Pension Risk,” the firm said DB plan
fiduciaries should coordinate across four “levers” that can help
improve funded status and mitigate negative impacts of
under-funding on corporate financials.
These
levers are:
· Asset Returns: Maximizing
investment returns from growth assets, like public equities and
alternative investments;
· Liability Hedges: Optimizing
investments in liability-hedging assets, such as bonds, to hedge
key liability risks, including interest rate risk;
· Contribution Policy: Having an
established plan and set of guidelines around when and how to
make incremental corporate contributions to the plan; and
· Benefit Management: Altering
future benefit structures, policies, or strategies.
No lever
alone is enough to close the pension funding gap, according to
the report. For example, consider a hypothetical defined benefit
plan that is 80% funded ($1 billion liability; $800 million in
assets). To reach 100% funded status in five years, relying only
on growth asset investment returns would require an unrealistic
15.7% return in each of the five years. Similarly, it would take
an unlikely 5.5% increase in interest rates over five years for
the liability to shrink and close the funding gap. This
hypothetical plan would need to contribute $67 million per year
to close the gap with contributions alone.
Considerations
for each lever
The report
outlines considerations that CFOs and financial executives should
keep in mind for each of the four levers. For one, creative use
of illiquid and other strategies can help grow plan assets.
According
to the report, returns from growth-oriented asset classes are the
primary engine with which DB plans can grow assets relative to
liabilities and close their funding gaps. But over the next 10
years, Cambridge Associates’ analysis projects low-single digit
returns from traditional growth assets, such as global equities,
which will not be enough for most plans to meet their spending
requirements. Plan sponsors may benefit from looking to private
equity and other illiquid asset classes, which have historically
outpaced traditional assets’ returns and which are expected to
outperform by even wider margins in the decade ahead.
Most
corporate pensions in the U.S. can likely afford to invest more
in illiquid investments than they think, the report says. And, by
under-allocating to these investments they may be exposing their
plans to unnecessary risk. Also, some growth portfolio assets can
act as liability-hedging or “de-risking” assets; these
investments allow plan sponsors to hedge against interest-rate
risk without reducing allocation to growth, essentially “having
one’s cake and eating it too.”
Secondly,
mismanaging liability hedges can actually raise portfolio risk.
According to the report, while liability-hedging assets, such as
longer-duration bonds, can minimize the effect of interest-rate
changes on the value of the plan’s liabilities (and therefore how
it appears on the company balance sheet today), many DB plan
sponsors may not be fully hedging their liabilities, betting too
much on interest rate increases in the near future. If long
maturity rates do not rise or rise very slowly, the value of
liabilities may grow faster than plan assets, which could
negatively impact balance sheets. Click
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