Many pension-plan sponsors are making large voluntary contributions to their plans this year. Pension-funding rules allow such contributions to be retroactively recorded for 2017 if they’re made by Sept. 15.
The payments are tax deductible, of course, and because of the reduced corporate income tax rate that took effect Jan. 1, deductions claimed for 2017 are worth a lot more than those claimed for 2018.
But some plan sponsors are apparently ignorant of that opportunity, which is only one part of a wider opportunity that they’re also missing out on.
It’s been three decades since the Pension Benefit Guaranty Corp. began assessing “variable-rate premiums” (VRPs) on pension-plan sponsors. Yet, rather bizarrely, there are sponsors that still don’t exploit aspects of pension law that would allow them to lower their VRP payments.
All sponsors pay an annual, “flat-rate,” per-participant premium (it’s $74 for 2018). The VRP is an additional payment for those with unfunded plan liabilities. For 2018 the VRP rate is 3.8% of the unfunded amount.
The VRP has been rising sharply in recent years, greatly increasing costs for underfunded plans. The rate was 3.4% in for 2017 and is scheduled to be 4.2% for 2019. Indexed to wage growth, it’s expected to reach 7% by 2040, absent action by Congress.
That makes it all the more surprising that 195 pension-plan sponsors each left more than $100,000 on the table for their 2016 plan years by not adhering to some simply accomplished best practices.
Those figures are according to retirement-plan adviser October Three, which reviewed publicly available information on all of the approximately 5,000 single-employer defined-benefit pension plans with at least 250 participants.
Rules for such plans require plan sponsors to calculate a plan’s funded status as of Jan. 1 of each year. The calculation, which must be completed by the following Sept. 15, determines whether they will owe a VRP that year, and if so how much they will owe. That amount must be paid by Oct. 15.
The rules also require sponsors to make four quarterly minimum contributions to their plans, by Jan. 15, April 15, July 15, and Oct. 15. However, sponsors are allowed to record contributions made by Sept. 15 as contributions for the prior year. These are called “grace-period contributions.”
Making them increases plan assets as of the Jan. 1 valuation date, thereby reducing, or even potentially eliminating, the VRP amount owed for that year. Based on the 3.4% VRP rate for 2017, grace-period contributions for 2017 totaling $10 million, for example, will save the plan sponsor $340,000.
Because of the way minimum contributions are calculated, a plan sponsor’s four quarterly contributions may add up to less than the total amount required to be contributed for the year. In that case, the sponsor must make a “residual contribution” by the following Sept. 15. But in order to make grace-period contributions on April 15 or July 15, the residual contribution must be made by April 15.
The retroactive recording option is not available to plans that are less than 80% funded. But there is no reason for any plan sponsor that can take advantage of it not to do so, says October Three partner Brian Donohue. No additional effort or expense is required to record plan contributions for the prior year.
Failure to record eligible contributions for the prior year, which October Three calls a “recording error,” is just one of the best practices allowing plan sponsors to minimize their VRPs.
Another one is simply making contributions earlier than required. Paying residual contributions three months early, as described above, is just one example of this. If a plan sponsor accelerates its required Oct. 15 contribution by one month and, and the following Jan. 15 contribution by four months, those too can be recorded for the prior year.
Further, any voluntary contributions a plan sponsor opts to make can be recorded for the prior year as well, if made by Sept. 15.
From 2010 through 2016, plan sponsors that didn’t adhere to these best practices collectively paid approximately $1 billion more in PBGC premiums than they needed to, according to October Three.
But why don’t they adhere to the best practices?
There isn’t an easy answer. But for many years after the PBGC initiated variable-rate premiums in 1988, the rates were so low that the dollars to be saved were fairly negligible, Donohue points out. The opportunity just never got on some plan sponsors’ radar screens.
Typically, actuaries at plan advisers like October Three made their clients aware of it, but in some cases perhaps not, Donohue muses. “An actuary’s first responsibility is to keep the plan compliant, and this is not a compliance issue,” he says.
New pension-funding rules that took effect in 2012, as well as subsequent legislation, have combined to propel VRP rates several times higher than they had been. “We’ve talked to some of these companies that aren’t doing the best practices and told them about this,” Donohue says. “As often as not, they’re stunned.”