Defined benefit plan sponsors have gained a new incentive to fully fund their pension plans – even if that requires borrowing, according to a recent research report.
The Moving Ahead for Progress in the 21st Century Act enacted in mid-2012 raised U.S. Pension Benefit Guaranty Corp. premiums for plan sponsors maintaining an underfunded DB plan, a funding level dictated by the Pension Protection Act of 2006 as being an adjusted funding target attainment percentage of 60 percent or less. At the same time, MAP-21 provided a certain amount of flexibility in setting contribution schedules. In other words, plan sponsors now have to choose between delaying their pension contributions, and therefore paying higher PBGC premiums over a longer term, or fully funding the plan to avoid those premiums to the federal insurance system for corporate pensions.
Since MAP-21act became law, the Bipartisan Budget Act of 2013 further lifted PBGC premiums for underfunded plan sponsors. As a result of this legislation, pension plan sponsors have gained an “incentive to fully fund their plans rather than delay funding” because borrowing to fund the plan erases the variable premiums and allows the sponsor to take advantage of tax arbitrage, if contributions and loan payments are tax-deductible, a report by institutional investment and consulting firm Russell Investments concluded.
In light of the new laws, the firm decided to revisit questions about funding raised in a 2012 Russell Research Practice Note, this time asking: Under what circumstances would it be advantageous for a sponsor to issue debt to fund the pension plan?
In “Do PBGC Premiums Incent Sponsors to Borrow to Fund Their Pension Plans?” published in late 2013, the investment firm said it becomes “fairly obvious” that if plan sponsors are able, because of a high credit rating, to borrow below the set repayment rate for the amortized underfunded amount, then they usually would prefer to issue debt, partly because a rate below 5 percent would lead to annual loan payments below the annual contribution to satisfy PBGC premium funding requirements.
However, if, because of a weaker credit rating or in an environment of rising interest rates, the borrowing rate is higher than 5 percent, the sponsor’s preference ought to be to fund the plan over time, because its annual loan payments would exceed the yearly contribution to the plan’s funded status.
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