However, if the plan sponsor acts now and contributes the $10 million by September 15, 2018, and applies it to 2017, the plan sponsor will receive a tax deduction based on the old 35% corporate tax rate. There also will be no variable PBGC premiums due as long as the plan remains fully funded. This means the plan’s total after-tax cost would be only $6.5 million for a net savings of $1.7 million! Companies that do not have the $10 million in cash available for these accelerated contributions could consider borrowing the money in the current low-interest-rate environment to take advantage of this opportunity, but they should consult with their legal and tax advisors before taking any action.
The Importance of Locking In Funded Status
A key step to consider when fully funding a DB plan is to lock in the plan’s funded status. The last thing a plan sponsor wants is to fully fund the plan and then have the stock market or interest rates drop, resulting in an underfunded plan next year.
One way to do this is with Pacific Secured Buy-In®, a relatively new risk-transfer solution. Buy-in annuity contracts have been used for many years in the U.K., but have only been available in the U.S. for about five years.
Pacific Secured Buy-In transfers all the pension risk associated with the DB plan liability to Pacific Life for those participants covered in the buy-in contract. To complete the contract, the plan sponsor makes a one-time payment to Pacific Life. From then on, Pacific Life pays a monthly bulk sum to the DB plan equal to the exact amount of benefits due to those plan participants who are still alive and receiving benefits. The pension plan uses this money to continue making individual payments to its participants.
The buy-in contract remains an asset of the plan, and Pacific Life provides a monthly contract value to the plan sponsor for accounting purposes. This means the liability and assets remain on the plan sponsor’s balance sheet, but the funded status will now be more stable regardless of how long participants live or what happens with the stock market or interest rates.
Flexibility for Plan Sponsors
With Pacific Secured Buy-In, the plan sponsor can continue the contract for as long as needed. The contract also can be converted to a buy-out contract at any time for no additional fee. For example, let’s say a plan sponsor has just started the plan termination process but will not be ready to complete that process for six to 18 months. With Pacific Secured Buy-In, the sponsor doesn’t have to worry about what happens to the market or interest rates in the meantime.
We expect most plan sponsors will want to convert the buy-in to a buy-out within a few years after purchase of the buy-in. This is because, with a buy-in contract, the liability remains on the plan sponsor’s balance sheet. Thus, the plan sponsor is still paying all administrative expenses for maintaining the plan. For example, even though Pacific Secured Buy-In can help keep the plan fully funded to avoid future variable PBGC premiums, the plan sponsor still has to pay the fixed per-participant PBGC premiums each year, which will be $80 per participant in 2019.
No Settlement at Buy-In
An important feature of Pacific Secured Buy-In is that it does not trigger a pension settlement while the buy-in is active. Thus, the company need not recognize in income any unrecognized pension loss it currently has on its balance sheet when it executes the buy-in. With a buy-out, all or a portion of the loss would have to be recognized. Many companies don’t want to recognize a pension loss in the current year. For U.S. companies, any pension loss would typically be recognized in income in the year the buy-in is converted to a buy-out.
A Bonus for Multinational Companies
In addition to all the advantages discussed thus far, Pacific Secured Buy-In offers an additional advantage for multinational companies operating under International Financial Reporting Standards (IFRS) accounting. Under IFRS, not only is any pension loss not recognized in income at the time of the buy-in, but it also may not be recognized in income upon conversion to a buy-out. A company that did not use a buy-in first and, instead, started with a buy-out would have to recognize any pension loss in income in the year the buy-out contract was executed. However, if the company first uses a buy-in and later converts to a buy-out, the pension loss may never be reflected in income. The buy-in transition will simply be accounted for as a balance-sheet adjustment. This makes Pacific Secured Buy-In an important consideration for any multinational company considering a pension risk-transfer transaction for a` U.S. pension plan.
Pacific Life refers to Pacific Life Insurance Company. Insurance products are issued by Pacific Life in all states except in New York. Guarantees are backed by the financial strength and claims-paying ability of the issuing insurance company. Pacific Life is a product provider. It is not a fiduciary and therefore does not give advice or make recommendations regarding insurance or investment products. Only an advisor who is also a fiduciary is required to advise if the product purchase and any subsequent action taken with regard to the product are in their client’s best interest. Pacific Life, its affiliates, its distributors, and respective representatives do not provide any employer-sponsored qualified plan administrative services or impartial advice about investments and do not act in a fiduciary capacity for any plan.