Number of DB plan closures could increase in 2017
Defined contribution plan sponsors need to pay close attention to tax law changes, rising PBGC premiums and an expected rise in interest rates in the upcoming year.
Michael Archer, leader of the Client Solutions Group at Willis Towers Watson’s North American retirement practice, says that an expected drop in the corporate income tax and an expected rise in interest rates will make it easier for defined benefit plan sponsors to terminate their retirement plans in 2017.
President-elect Donald Trump’s platform advocates for a reduction in the corporate income tax rate, but that means retirement plan sponsors will get less of a deduction in the future by making a contribution to their defined contribution or defined benefit retirement plans, he says.
“You can contribute $1,000 today and get a deduction of $350 and it only costs you $650, or you can make a contribution in the future, get a deduction for $200 and it costs you $800,” Archer says. “What’s interesting about the changes in corporate tax rules is it can be retroactive to the beginning of the fiscal year.”
Under the current rules governing DB plans, a plan sponsor has 8.5 months following the close of the plan year to make a contribution and assign it to the prior plan year and assign it to the prior tax year, Archer says.
So if a plan operates on a calendar year schedule, the plan sponsor would have until Sept. 15, 2017, to make a contribution for 2016 and claim it on their 2016 tax assessment.
“If we get tax legislation that reduces corporate income taxes and is retroactive to the beginning of the year, we will see many plan sponsors make contributions in advance and fund their plan balance. They will do it because they are faced with PBGC premiums, which are increasing at a rapid rate, and those increases affect the cost of debt in retirement plans,” he says. “Now there are two incentives to fund and fund now because of the bigger deduction and they get out of paying the variable premium.”
In the past few years, DB plan sponsors have frozen their plans, offered lump sum payments to plan participants or purchased annuities for participants to get out from under their DB plan’s crippling debt. Because of the expected change in the corporate tax rate and an expected rise in interest rates, plans should see their funded status increase.
“The amount of settlement activity out of plan sponsors is likely to dramatically increase,” Archer says.
The changing financial landscape could also impact the types of investments plans seek out. Well-funded plans will likely move from equity to fixed income, hedging strategies, he adds.
“If a plan is not particularly well-funded, it may want to stay in equities and hope that will help its underfunding so they don’t have to pay more in cash contributions,” he says. “Ultimately, we will see an increase in plan termination activity.”
Archer encourages 401(k) plan sponsors to pay attention to the fees that are charged and the investment options they offer and also keep abreast of general compliance issues in the new year.
Regulatory bodies like the IRS and Department of Labor have increased the number of audits they are doing and the amount of attention they are paying to retirement plans.
“The focus on compliance is really important,” he says.
Archer pointed out that the Department of Labor has been sending letters to plan participants who are over the plan’s normal retirement age reminding them they can start their benefits.
“That kind of outreach hasn’t been seen before,” he says.
Plan sponsors should do everything they can as a plan fiduciary to make sure they have really good processes in place and good documentation of those processes. “If they don’t have that; if they haven’t done a compliance review, they would be well-served to do it” because of the increase in plan litigation and the increased attention paid by regulatory bodies to retirement plans in the past couple of years, Archer says.
The IRS recently issued proposed regulations that would establish new mortality tables for DB plans that would be used for minimum funding requirement purposes and the calculation of lump sums and what they would get for annuity benefits. The regulation won’t go into effect until Jan. 1 of next year, but plans need to keep this in mind for their future required plan contributions.
Administrative systems will have to be changed to calculate lump sums next year and those changes will need to be put in place by the second half of 2017, he says.