Time Is Running Out to Optimize Contribution Tax Efficiency

by | bytesize, Defined Benefit, Plan Termination

Even though, the 2017 tax changes have been covered extensively, some retirement plan sponsors are not aware that pension plan contributions made after September 15, 2018 will be materially more expensive for employers under the new law. This is because the reduction in the corporate income tax rate reduces the tax savings from retirement plan contributions. Contributions made before September 15, 2018 can be deducted against 2017 profits. The 2017 maximum corporate tax rate was 35%. The rate drops to 21% in 2018 and beyond. Therefore the tax deduction for pension plan contributions drops 14%!

Let’s walk through this with some numbers. A corporate pension plan sponsor paying the maximum 2017 35% marginal rate receives a 35% “refund” of pension contributions through a reduction in their tax liability. A $100,000 contribution for the 2017 tax and plan year reduces this sponsor’s tax bill by $35,000. Therefore, the after-tax cost of the contribution would only be $65,000. However, with the new, 21% tax rate, the value of the “refund” will be reduced to 21%. So, under the new law, the same pre-tax contribution of $100,000 would have an after-tax cost of $79,000 – $14,000 higher than under the old law.

The good news is that there is still time to take advantage of the old, higher deduction! The bad news is that time is short, with the opportunity to save set to expire September 15th for most plan sponsors.

Plan sponsors with frozen plans should be particularly interested in this opportunity. Terminations often involve a final “top up” contribution to fully fund the cost of terminating the plan. Whether a frozen plan sponsor is looking to terminate their plan next year or in the next 5 – 10 years, they should consider making some or all of that “top up” contribution now, before the opportunity to take advantage of the higher deduction expires.

At the same time, plans with ongoing accruals most likely have continued annual funding obligations. These plans could pre-fund the next 3-5 years’ worth of required contributions now, lock in their tax savings, and then take credit for that discretionary funding to satisfy their contribution requirements for the next several years.

Sponsors who pay PBGC Variable Rate Premiums could potentially save even more! No matter what your situation, you should consider taking advantage of this window of opportunity. Most sponsors will have to act by September 15th – time is running out!

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