Tax-reform legislation has important implications for pension funding strategies, as it will cause the headline corporate tax rate to drop from 35% to 21% in 2018. The advantages of pre-funding are more compelling than ever before, as the after-tax cost of funding pension plans will increase following the changes, and many will take the opportunity to capitalize on the greater current tax deduction, thus avoiding these cost increases. In fact, about 75% of plan sponsors are already accelerating pension funding or considering doing so.
It is noteworthy that the window of opportunity to make tax-deductible contributions for the 2017 tax year is short. For retiree medical plans, funding (typically through a VEBA) would need to be completed in 2017. For defined benefit plans, the tax year typically extends until 8 1/2 months after the end of the tax year or, if earlier, the due date of the 2017 corporate tax return (including any filing extensions).
Companies that elect to take advantage of the pre-funding opportunity may also see other potential benefits, such as:
- Improved earnings
- Reduced PBGC premiums
- Lower impact on existing deferred tax assets
- Accelerated movement along an existing glide path
- Opportunities for risk transfer
Keep in mind: Funding is only the first step. In conjunction with funding decisions, plan sponsors should also think about the longer-term strategy for their plans, including implications on investment policy, pension risk transfer actions and how they will manage their plans in the future. Taking these longer-term goals into account can provide opportunities to further manage financial risk, whether through a shift to a greater LDI focus, the implementation of a hibernation strategy, partial risk transfer or, for frozen plans, to terminate altogether.
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