How Corporate America is Spending Its Tax Savings

With Corporate America finally getting their wish for a lower headline corporate tax rate fulfilled, a recent poll by Willis Towers Watson shows how the decision makers plan to spend their new windfall from the Tax Cuts and Jobs Act.

The survey of 333 large and midsize employers reveals the following plans by category:

Employee Benefits:

1.) 66 percent are planning, considering or have already taken action on making changes to their benefits programs.

2.) 34 percent are planning or considering expanding personal financial planning.

3.) 26 percent are planning or considering increasing 401(k) contributions.

4.) 19 percent are planning or considering increasing or accelerating pension plan contributions.

Employee Compensation:

5.) 64 percent are planning, considering or have already taken action on their broad-based employee compensation programs.

6.) 43 percent are planning or considering conducting a review of their compensation philosophy.

7.) 36 percent are planning or considering addressing pay-gap issues.

8.) 21 percent are planning or considering introducing a profit-sharing or one-time bonus payout to all employees.

Executive Compensation:

9.) 41 percent are planning, considering or have already taken action to change their executive pay programs.

10.) 33 percent are planning or considering spending more time and analysis on this year's incentive targets.

11.) 19 percent are planning or considering increasing the use of discretion in 2018 executive compensation plans.

According to Bloomberg, only 4 percent of companies stated that, in light of the Tax Cuts and Jobs Act, they had raised wages for all employees and an additional 3 percent stated that they planned to do so in the next year.  In contrast, 80 percent of companies stated that they aren't giving any raises whatsoever.  

Now, let's look at another poll by Willis Towers Watson which shows us where Corporate America could be (and should be) spending at least some of their new tax lottery winnings.  According to a 2017 year end poll of 389 Fortune 1000 companies that sponsor defined benefit pension plans with a year end of December, the funding levels of private defined benefit pension plans has not improved significantly since the depths of the Great Recession as shown here:

It is interesting to see that, despite the robust stock and bond markets since 2014, the aggregate funding level of America's largest private sector defined benefit pension plans has shown negligible improvement.  In fact, the pension deficit at the end of 2017 is projected to be $292 billion compared to assets of $1.43 trillion.  Companies did contribute $51 billion to their pension plans in 2017, double the amount needed to cover benefits accruing during the year, however, plans are still significantly underfunded with total pension plan obligations rising to $1.72 trillion in 2017 from $1.65 trillion in 2016 as baby boomers start leaving the workforce.

While Corporate America is delighted with the prospect of lower taxes, unless executives start taking significant measures to roll back their defined benefit pension plan deficits, Main Street America will find that the "shiny, one time baubles" that are offered by a relatively small fraction of American corporations thanks to the Tax Cuts and Jobs Act will pale into insignificance when it comes to retirement time.  With only 19 percent planning or considering increasing pension plan contributions as a result of the new lower corporate tax regime, it looks like it's going to be a cat food future for millions of American workers.

Retirement Inequality in America

When we think of income inequality in North America and Europe, we often associate the massive differential between executive salaries, particularly those at the top of the corporate heap, and the relatively tiny compensation that is paid to an average worker as a guide to the degree of income inequality in our society today.  What is rarely considered is how income will look after retirement for both groups.  Fortunately, a recent study by the Center for Effective Government and the Institute for Policy Studies examines the vast differential in retirement benefits between the two groups.

Let's start with a few facts:

1.) The 100 biggest retirement funds set aside for CEOs are worth a total of $4.9 billion, equal to the retirement savings of 50 million American families (which represents 41 percent of all American families) or 116 million Americans.  Here is a table showing the ten largest CEO retirement funds:

2.) The largest retirement fund in the Fortune 500 is held by David Novak, CEO/Executive Chairman of YUM Brands, the owner of Taco Bell, Pizza Hut and KFC and is worth $234 million.   This will generate a monthly income cheque of $1.3 million upon his retirement.   It is key to note that hundreds of thousands of his employees have no company-sponsored retirement plans.  Those 8828 employees that do have account balances in a 401(k) have an average value of $70,167 and will generate $395 per month in retirement income.  

3.) On average, the value of these CEO retirement plans are worth more than $49.3 million, a size that is large enough to generate a monthly income cheque of $277,686, equivalent to roughly five times the annual income of an American family unit.

4.) Tax deferment works in the favour of these CEOs; Fortune 500 CEOs have saved $78 million on their 2014 tax bills alone by putting an additional $197 million into these tax-deferred compensation accounts than they could have if they were under the same tax regulations as the "sweaty masses".  Here is a table showing the ten largest CEO Deferred Compensation Accounts:

In 2014, the largest deferred compensation contribution belonged to Glenn Renwick, CEO of the Progressive Corporation, who invested $26.2 million in his tax-deferred compensation account which saved him more than $10 million in federal taxes.

        

5.) Only 18 percent of private sector workers had a defined benefit pension, a drop of nearly 50 percent from the 35 percent level seen in 1990.  On the other side of the coin, 52 percent of Fortune 500 CEOs have a company-sponsored retirement plan.  As well, nearly 75 percent of Fortune 500 companies have set up tax-deferred compensation plans for their executives that are similar to 401(k) plans that ordinary workers have access to.  The biggest difference is that there is a limit to how much pre-tax income ordinary workers can contribute to their 401(k)s (workers 50 years of age and older can contribute $24,000 annually); in the case of executive compensation plans, there is no limit which allows them to shelter unlimited amounts in these plans tax-free.

With this information in mind, I find it particularly galling that many American corporations have minimized their pension liabilities by converting defined benefit pension plans to defined contribution plans.  By doing this, companies shield themselves and it is the working class who bears the burden of saving sufficient cash to provide themselves with a financially secure retirement.  While defined benefit plans were the norm in the 1980s and 1990s, by 2011, three times as many private section workers had a defined contribution pension plan when compared to those that had a traditional defined benefit pension plan as show on this graphic:

In closing, let's summarize this posting by looking at the pension status and pension funding levels of the ten corporations with the largest CEO retirement accounts that we observed on the first table:

With millions of baby boomers wondering how they are going to make ends meet after they retire (if indeed they can afford to retire), it's comforting to know that a few hundred Americans are going to have no retirement worries whatsoever.

Our Longevity and the Impact on America's Pension Plan Funding Levels

Even though the stock market has done this over the past two years:

  

...and bond prices have risen over the same two year period, according to the annual corporate pension plan funding levels report by Towers Watson, the aggregate funding status (i.e. the overall funding status) of the pension plans managed by the 411 largest Fortune 1000 companies dropped significantly over 2014.

Here is a bar graph that shows the funding level for each year since 2000:

As I noted above, despite the banner year in both the stock and bond markets in 2014, employer-sponsored pension plans saw their funding level drop to just aloe the level seen in 2008 when the world's economy was near collapse.

Over the year, pension plan assets increased by 3 percent, from $1.36 trillion in 2013 to $1.4 trillion in 2014, largely on an average investment return of 9 percent for all classes of assets.  The returns varied considerably among classes with a 14 percent positive return on large-cap United States equities and a 5 percent negative return on international equities.  On top of the returns on assets, companies contributed an additional $30 billion to their pension plans during 2014, the lowest level of contributions since 2008.

Given the reasonable return on investments, why did the funding level of employer-sponsored pension plans drop by 9 percentage points over 2014?  It is largely a result of an actuarial readjustment.  The Society of Actuaries (SOA) periodically reviews the mortality rates of retirees to determine the impact of our lifespan on the funding requirements of pension plans.  In the most recent mortality study, the SOA looked at 123 private and public/federal pension plans over the years from 2004 to 2008 which reflected approximately 10.5 million life years of exposure and more than 220,000 deaths.  From this data, the SOA found the following:

1.) Males: among males aged 65, overall longevity rose 2.0 years from age 84.6 in 2000 to age 86.6 in 2014.

2.) Females: among females aged 65, overall longevity rose 2.4 years from age 86.4 in 2000 to age 88.8 in 2014.

Based on this data, the SOA estimates that there is a four to eight percent increase in private pension plan liabilities, depending on the individual pension plan.  In other words, because we are living longer, pension plans are required to pay pension benefits for a longer period of time (i.e. we are a liability for a longer period of time), meaning that companies must increase their returns on investment or increase the level of their contributions or some combination of the two.

This will have an ongoing impact as baby boomers continue to retire.  Over the coming decade and a half as the last of the baby boomers reaches the age of 65, if longevity continues to increase at the same time as the number of retirees mushrooms, pension plan managers could find themselves under significant pressure to maintain reasonable funding levels.  Excluding the impact of either a significant and long-duration bond or stock market correction, it is becoming clear that pension plans could well be the biggest Ponzi scheme of the last century.