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.
However, he notes that some DB plan sponsors may not find a borrow-to-fund strategy as compelling as before the enactment of tax reform. “In particular, for certain companies, interest deductions are generally limited to 30% of Earnings Before Interest, Taxes, Depreciation and Amortization (EBITDA) for tax years beginning before 1/1/2022, and to 30% of Earnings Before Interest and Taxes (EBIT) for subsequent tax years. Given this, the ability to use existing corporate cash for pension funding may become more critical,” he says.
Moran also warns that increased flexibility around cash may mean that some U.S. multi-nationals may not need to issue as many bonds going forward to fund buybacks, dividend increases, capital expenditures, etc. “Just as more corporate DB plans are looking to add long-duration fixed income to their portfolios as funded ratios move higher from contribution activity, the new supply of long duration fixed income securities may decline,” he says.