What will tax reform mean for defined benefit pension investing?

elderly couple sitting at a table looking at paperwork

If you’re like me, tax season isn’t a time of the year I look forward to by any stretch. Gathering last year’s paperwork and navigating through the endless software that’s supposed to make filing easy isn’t a way I like to spend my free time.

But next year’s filing season will be a little different, thanks to the newly passed tax reform bill, which has provided a silver lining in the form of lower tax rates. And I’m already starting to think about how I’ll put the extra dollars I get from next year’s refund to work.

As I started to research investment ideas, I realized that individuals like myself won’t be the only ones benefiting from the reforms, but corporations will as well. Currently, they’re in the process of evaluating the impact on their corporate capital structure, changes in taxes and where they should be allocating money to manage pension funds. In doing so, they’re already impacting the investment landscape in a number of ways.

Striking the right balance between risk and safety

There are extensive investment programs to manage the funds that are set aside for employee pensions. Though the process is complex, it essentially requires striking the right balance of risky (i.e., equities) and safe (i.e., fixed income) assets.

Fixed income becomes increasingly important as plans move closer to funding targets and begin de-risking. Many plans have also benefited from strong equity market appreciation in recent years, further enhancing funding levels and increasing the ability of plans to meet obligations. Therefore, many will consider rebalancing their investment portfolios in favor of fixed income assets, which can provide greater stability as plans mature or near targets.

Corporations also have the option to increase contributions to their defined benefit plans, and if done before September 15, many will be able to deduct those contributions based on the higher 2017 tax rates. So, not only are they moving money from equities to fixed income, but there’s the possibility of additional money being added to the plans that could be flowing into fixed income as well.

Both of these factors could increase demand for traditional higher quality fixed income securities from pension funds. But there are other tax reform factors which may influence the supply of these securities going forward.

Final thoughts

Clearly tax reform will turn out to be much more than just a few extra dollars in our pockets. The effects on both parts of the market are already being felt. For more on that, check out our recently published white paper, Pension funds and tax reform: how to deal with a double-edged sword. In it we examine how these events could pose a variety of risks to pension funds and key measures companies can take to get the most out of their fixed income portfolios in particular.

Disclaimer:

The information included in this presentation is intended for general educational purposes only and should not be relied upon without further review with your Willis Towers Watson consultant. The information included in this presentation is not based on the particular investment situation or requirements of any specific trust, plan, fiduciary, plan participant or beneficiary, endowment, or any other fund; any examples or illustrations used in this presentation are hypothetical.

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Brett Vanover, Senior Research Analyst at Willis Towers WatsonBrett Vanover is a Senior Research Analyst at Willis Towers Watson.

 

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