A New Look at Pension Plan Investing in 2018

Willis Towers Watson outlines 10 ways sponsors need to modernize investment focus for their pension plans.

In “Ten Investment Actions for DB Plans in 2018,” Willis Towers Watson updates 10 terms that have traditionally been used with respect to defined benefit (DB) plans—but says each needs to be revisited in light of regulatory and market developments.

First off, pension plans have dealt with their fiduciary duties by ensuring that any decisions made with respect to the plan are reasonable and documented. In today’s world, Willis Towers Watson says, that won’t fly because DB plans are being held to a higher level of scrutiny than ever before and more parties are considered fiduciaries—and expected to be experts.

Secondly, pension plans have been considered fully funded when their assets have been equal to or exceeded accounting liabilities. The consulting firm says pension plan sponsors need to be more diligent about ensuring that their assets will, indeed, support future benefits for employees.

In the past, pension plans considered their time horizon to be a very long period of time until they would need to make their last benefit payment. In fact, Willis Towers Watson says, because people retire at different points, pension plan sponsors need to be aware that in some cases, their investment time horizon can be very short.

Fourth, pension plans have traditionally decided on an asset allocation strategy and accompanying investment managers and let their decisions rest. Today, Willis Towers Watson says, pension plan sponsors need to continually monitor their investments in light of changing market conditions, saying that in today’s world, a pension plan needs to adopt “the dynamic process of achieving a series of risk allocations that vary with market conditions and reflect the plan’s progress toward its funding and settlement objectives.”

NEXT: Interest rate risk

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Fifth, pension plans have traditionally maintained a short position relative to rises or decreases in interest rates. Today, the consulting firm says, pension plans need to price interest rate increases “into the forward curve, meaning potential gains … are lower than one might expect.”

Sixth, pension plans have handled liability-driven investing (LDI) by extending their interest rate exposure through long-duration fixed income investments. Today, Willis Towers Watson says, this “can extend beyond long-duration fixed-income assets.”

Seventh, pension plans in the past have diversified their portfolios by investing in various regions of the globe and investment styles, such as value, growth and momentum. Today, Willis Towers Watson says, pension plan managers need to use a greater variety of investments and consider new investment ideas.

Eighth, in the past, pension plan fiduciary committees have met infrequently. Today, Willis Towers Watson recommends that they become more proactive and meet more regularly.

Ninth, pension plan committees have become accustomed to outsourcing just investment manager selection to a third party. Willis Towers Watson suggests that pension plans outsource the entire investment management process to make it more efficient and less costly and to free up management to focus on their business at hand.

Finally, Willis Towers Watson implores pension plans to focus less on short term investment return goals and “ultimately secure benefits for all plan participants.”

The report can be downloaded here.

GOP Backs Away From Limits on Deferred Compensation

Among other amendments that have already emerged in both the House and the Senate tax proposals, it seems nonqualified deferred compensation plans will more or less be left alone. 

Both the preliminary versions of the House and Senate tax reform proposals would have made major changes to the treatment of deferred compensation for executives and highly-paid employees.

However, following the earliest stages of debate, both the House and the Senate seem to have backed away from major changes to deferred compensation arrangements, as well as from other retirement-industry focused proposals. 

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As the law currently stands, compensation is generally includible in an employee’s income when paid to the employee. However, in the case of a nonqualified deferred compensation plan, unless the arrangement either is exempt from or meets the requirements of Treasury Regulation 409A, the amount of deferred compensation is first includible in income for the taxable year “when not subject to a substantial risk of forfeiture,” even if payment will not occur until a later year. In general, to meet the requirements of section 409A, the time when nonqualified deferred compensation will be paid, as well as the amount, must be specified at the time of deferral, with limits placed on further deferral after the time for payment. Various other requirements apply, including that payment can only occur on specific defined events.

This system would have be changed dramatically under the first drafts of tax reform proposals released on both houses of Congress. Under the preliminary Senate bill, for example, 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 House Ways and Means Committee had included similar language in its initial tax bill, but since then the language was already amended out of the tax bill prior to its clearing the committee. And news has emerged that the Senate has “stricken” its proposals regarding deferred compensation. It also seems to be the case that the House and Senate are backing away from the limitation of catch-up contributions for high-wage employees, and from the proposal to implement a 10% penalty tax for early withdrawals made prior to age 59½ from governmental section 457(b) plans.

Of course, both the House and the Senate are still just getting started on tax reform. This tax reform effort will take some time to pan out, and preliminary details may change by the time actual legislation is voted on by the full House and Senate. 

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