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Aon Retirement and Investment Blog

Potential U.S. Corporate Tax Reform Presents Prefunding Opportunity in 2016

Recently, we’ve consulted with a number of plan sponsors who believe they may be able to optimize the tax benefits associated with their retirement plan obligations by prefunding these benefits in 2016. The outcome of the U.S. presidential election has persuaded these sponsors that corporate federal income tax rates may be lower in 2017 than in 2016, thereby increasing the incentive to prefund retirement plan obligations in 2016. Most of this activity is the result of a proposal from president-elect Donald Trump’s campaign to reduce the corporate federal income tax rate from 35% to 15%. If enacted, such a change could make a deduction in 2016 more than twice as valuable as a deduction in 2017.
For example, if the federal corporate income tax rate is lowered from 35% to 15%, a plan sponsor with a $100M obligation could prefund the entire obligation in 2016 to save approximately $20M in taxes. Of course, tax reform is not a sure thing. Any proposal could take a fair amount of time to reach resolution (perhaps extending beyond 2017), even with one party controlling the U.S. legislative and executive branches.

Impact for Pension Plans

Deductible contributions to qualified pension plans can generally be delayed by as much as 8-1/2 months following the close of the tax year. Sponsors should coordinate these contributions with the timing of their 2016 corporate tax filings. We expect that most sponsors will take a “wait-and-see” approach for pension contributions, given that there is less incentive to finalize a contribution before December 31, 2016.
Plan sponsors who have already considered “borrow-to-fund,” or other contribution acceleration strategies, may want to revisit that analysis given this potential new tax regime. For additional background, see our Pension Funding Strategy whitepaper.
Large corporations with significant sums of cash overseas may want to consider other short-term borrowing strategies, in the hopes that repatriation of those earnings may also become a more attractive option under Trump-era corporate tax rules.

Impact for Retiree Medical Plans

Assuming no other funding vehicle already exists, the cleanest and most expedient method to take advantage of this potential opportunity is most likely through a Voluntary Employee Beneficiary Association (VEBA) trust. Plan sponsors can set up and fund a retiree medical VEBA in a short amount of time. Note that the timeframe is important since funding would need to be complete by the end of the calendar year. The maximum deductible amount depends on the type of VEBA. Collectively bargained VEBAs have higher deductible contribution limits and investment returns are generally tax-free. Non-collectively bargained VEBAs have lower deductible contribution limits and are subject to an unrelated business income tax (UBIT) on investment returns. Prefunded retiree medical VEBAs can result in excess assets if benefits change in the future, so care should be taken not to overfund these vehicles. We are able to work with plan sponsors to estimate an appropriate funding amount for 2016 or to identify other appropriate funding vehicles.
One additional benefit of prefunding a retiree medical plan is that the assets would be expected to earn a return on investment. Such investment returns could lower the employer-paid cost of these benefits in the long run.
Obviously this opportunity is not relevant for tax-exempt entities, or taxable entities with little or no taxable income. Aon Hewitt does not provide tax advice. All plan sponsors should seek the advice of a qualified tax professional to discuss specifics of their situation prior to proceeding with a transaction.
Grant Martin is an actuarial consultant in Aon Hewitt’s U.S. Retirement practice, and is based in San Francisco, CA.

Content prepared for U.S. subscribers, but available to interested subscribers of other regions.

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