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Investment Management

Piloting Pension Moves as Tax Rates Fall and Interest Rates Rise

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September 10, 2018

By Antony Michels

Most MNCs still have more than a month to contribute to pensions and save on taxes.

Raytheon last week joined a long list of US multinationals responding to US tax reform by announcing tax-deductible contributions to defined benefit plans. The defense contractor, a member of NeuGroup’s Assistant Treasurers’ Group of Thirty, said it would make a $1.25 billion pension contribution by Sept. 15.

“Because of the timing of this contribution, making it here in the third quarter, we are able to deduct it at the prior statutory rate of 35% on our 2017 tax return giving us a financial benefit,” chief financial officer Toby O’Brien explained to Reuters. The contribution will reduce Raytheon’s effective tax rate and its cash flow this year, the company said.

Companies on calendar fiscal years, like Raytheon, have until Sept. 15 to make the contributions before the deduction falls to 21%, the new corporate tax rate. Most companies on non-calendar years have even more time to make contributions and receive the higher 35% deduction.

Several members attending NeuGroup’s Treasurers’ Group of Mega-Caps (tMega) first-half meeting discussed making pension contributions (ranging from $600 million to $5 billion) before the value of the tax deduction falls. And they’re not alone: Goldman Sachs said in a July report that S&P 500 companies contributed $63 billion to pension plans in 2017, and the firm expects another $60 billion this year.

Increased contributions to pensions and the resulting improvements in funding status are playing into another trend discussed by tMega and other peer group members: de-risking the plans. That includes moving more assets into fixed income, a move that has become more attractive as interest rates rise.

But Goldman’s report says de-risking goes beyond bonds, to the equity portion of a plan, noting that while “equity beta” has been the place to be post-financial crisis, “current valuations have led some to consider allocations to other alternatives such as defensive equity and/or low volatility equity strategies or hedge funds, as a way to de-risk the return-generating side of the portfolio.”

For some companies, de-risking also means transferring liabilities to a third-party insurer. Indeed, Raytheon told shareholders last week that some of the company’s pension plans purchased a group annuity contract to transfer $923 million of outstanding pension benefit obligations related to some previously discontinued operations.

However, at the tMega meeting, one member whose company still sees its pension as a differentiator attractive to employees asked whether offloading a pension to an insurer really eliminates the liability. One member answered, “If something goes wrong, employees/retirees are still going to name you in the lawsuit.”

Another issue those with pension responsibilities should keep in mind: More companies are contemplating the feasibility of shifting elements of nonqualified plans to qualified plans and optimizing the risk vs. tax deductibility trade in the process. Each company has a different wrinkle with its plan (e.g., one member company has a complicated profit-sharing arrangement embedded in it), and these distinctions and differences mean that companies will take different steps on their pension path.

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