Borrowing Considerations to Fund Retirement Plan Liabilities

Pension sponsors often deal with fluctuating annual contributions and a funded status that never seems to improve. A troubling reality since a well-funded plan and predictable plan contributions would obviously be ideal.

A pension plan’s annual contribution can be determined by considering the plan sponsor’s funding policy (limited by ERISA’s minimum contribution requirements). Nevertheless predictable annual contributions and a well-funded plan are both difficult to achieve. Even more so for under-funded plans.

When it comes to the more volatile under-funded plans, are fluctuating annual contributions the best strategy to improve the plan’s funded status? Maybe there’s a better way.

Plan sponsors of any size, especially organizations with a strong balance sheet and debt capacity, may have an untapped resource that could help, i.e., the capacity to borrow.

First, consider a one-time, larger contribution that could be financed. The amount might be determined 

• The next five years (or some specific period) of plan contributions
• An amount to fully fund the PBGC variable-rate premium liability
• Half of the plan’s current shortfall based on the funded status on the company’s balance sheet

What are the benefits of a larger single contribution to the pension plan?

• Eliminating the minimum required contribution for a period of time, creating a contribution holiday
• Paying back the loan with fixed annual payments that are potentially less than current contributions
• A balance-sheet-neutral transaction, exchanging a variable pension debt for a fixed debt
• A higher funded status that lowers investment risk by swapping volatile return-seeking assets for stable liability-hedging assets
• More benefit security allows additional de-risking action such as annuitization, or lump-sum settlements
• Increasing corporate earnings if the pension cost is lowered as a result of an immediate increase to plan assets
• Potentially lower PBGC variable-rate premiums
• Potential for taxable entities to deduct the borrowing costs

There are several considerations in evaluating whether a borrow-to-fund strategy is optimal:

• A large, financed contribution requires careful evaluation of the investment strategy for the plan, including the borrowed assets
• Taxable entities may want to delay a larger one-time contribution if higher corporate tax rates are expected soon
• An organization’s debt capacity may not be sufficient, or the company may need to keep some debt capacity for other business needs, such as acquisitions or capital improvements
• Depending on a variety of factors, the contribution may not generate a significant reduction to the PBGC variable-rate premium

It takes careful analysis to see if a borrow-to-fund transaction is right for your plan. For certain plan sponsors, a larger onetime financially engineered contribution could be an advantageous tactic. This approach may create a positive outcome on the funded status of the plan and reduce risk. It can lead to lower cash flow commitments for the near future, a balance sheet-neutral transaction, and improved earnings.

For more information about borrow-to-fund considerations, optimizing contribution strategies, or other retirement topics, contact Steven Bull, Actuarial Business Development, McGriff Retirement Consulting at (336) 291-1137 or sbull@mcgriff.com.