The funded status of 100 large U.S. pension plans stagnated the past three years, according to data compiled by Willis Towers Watson, but that’s not the whole story.
In 2016, overall pension plan contributions bounced back up to $30.9 billion from $20.6 billion in 2015, but six companies out of the 100 were responsible for contributing an additional $8.5 billion in 2016, compared to 2015.
“It is important to look behind the averages, what is actually going on plan by plan,” says Alan Glickstein, senior retirement consultant for Willis Towers Watson.
When Willis Towers Watson looked at the changes in funded status, it found that half of the 100 companies had a small change or slight decrease. Others had a small increase, but 12 improved their funded status and eight had a significant decrease. Seven of these companies were over 100% funded, but the average funded status was 82.4%.
Usually, funded status moves in waves. Corporations will fully fund their plans and then something will happen, like the stock market crash, which increases plan liabilities and decreases funded status. That process tends to repeat itself, Glickstein says.
“What we’ve seen in the last few years, particularly since the 2008 crisis, is we have not gotten back to 100% pension funding,” he says.
So what’s impacting pension plans? Glickstein says stagnant interest rates are to blame because over the past few years, investment returns have been very good and contributions to plans have been very strong, he says.
The rates used to determine the funded status of plans have “fallen steadily over the last nine years. We’re down in the low 4s and rates have fallen even further in 2017,” Glickstein says. In 2007, rates were in the mid-6s. “A relatively small change in interest rates has a big impact on pension liability,” he says.
The long-term corporate bond rate is what is used to determine a plan’s funded status. After the Great Recession, the rate was artificially depressed because of the government stimulus plan to help stimulate investment and boost the sagging economy.
Those efforts have slowly trailed off but “we haven’t seen a big uptick in rates,” Glickstein says. “The Fed is moving them up a bit, but they have fallen so far this year. It will be interesting to see if this is the new normal or an aberrational period and rates will come back up to where we’ve historically seen them or stop somewhere in the middle.”
One reason plan sponsors don’t rush to fully fund their pensions is that any small movement in interest rates or the stock market could push their plans over 100% funding.
Employers “don’t want to be the one who contributes an extra $100 million to the plan only to find out that equity markets were great and interest rates went up,” explains Glickstein, adding that most plans “hedge their bets. They don’t want to overshoot.”
If a company overfunds its plan, it can’t use that money for anything else in its business. Companies are penalized if they overfund their plans, he says. If they decide to terminate their plan and there is extra money in it, they will pay regular taxes on that money and a 50% excise tax on the remaining amount.
Many corporations have frozen or closed their pension plans to new hires. That helps get some of their pension liabilities off their books. It also helps reduce Pension Benefit Guaranty Corporation premiums if the assets of the plan are smaller. PBGC premiums have gone up dramatically in the past few years.
Tax reform could also have a major impact on pensions in the short-term. Currently, the corporate tax rate is 35%. President Donald Trump would like to lower that to 15%.
“This presents an interesting opportunity for plan sponsors,” says Glickstein. “Pension contributions are fully tax-deductible. You can get a tax deduction at the 35% tax rate.”
Before that goes into effect, there is an opportunity to front load a pension plan and reap the benefit of that 35% deduction rather than receive a 15% benefit in the future, he says. “We could see, depending on the how the prospects around tax reform play out, additional funding of plans related to that.”
He adds that it won’t happen until Sept. 15, because that is the last opportunity for plan sponsors to make contributions to their pension plan and treat them as if they were applied in the 2016 tax year and deducted in that year.
And even though there has been a trend to freeze or close pension plans, 60% of the Fortune 1000 companies still maintain a pension plan.
“From a plan sponsor perspective, there are still quite a lot of pension plans active out there,” he says. Most plans, even if they decide to close a plan to new hires, won’t terminate the plan right away.
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