Key Observations
• The combined expectations of the Tax Cuts and Jobs Act’s (tax reform) and shifting capital markets have created new and timely reasons for plan sponsors to evaluate their pension liabilities.
• The tax reform’s impact on pension contributions and projected increases in the Pension Benefit Guaranty Corporation (PBGC) Premiums, have produced incentives for plan sponsors to consider accelerating contributions to the plan.
• Complicating the decision are the prevailing conditions of capital markets and the current interest rate environment.
Tax reform & new incentives to accelerate contributions
With the passage of tax reform, management teams across industries are evaluating how the new legislation will impact their various business strategies. Among the common funding strategies for pension contributions are: 1) contributions from the firm’s balance sheet 2) asset allocation and 3) liability driven investment (LDI) strategies. However, this equation, has changed with tax reform revealing new opportunities and risks for plan sponsors.
A key provision of tax reform changes the tax treatment for employer contributions. The new legislation has reduced the corporate income tax rate to 21 percent from 35 percent; as well as the benefit of contributions made at the current tax rate by a 14 percent differential. Previously, pension contributions were tax-deductible at 35 percent; in-line with corporate income tax rate. There is, however, a caveat. Tax reform was enacted with a provision that extends making tax-deductible contributions at the previous rate of 35 percent. The extension schedule is as follows:
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