Forecasts for a more volatile stock market and continued low interest rates on traditional credit union fixed investments are giving credit union leaders pause about pre-funding defined benefit (DB) pension plans.
That’s typical and understandable. But that mindset can have opportunity costs.
Volatility in a DB plan’s investments is muted somewhat because the accounting rules for pension plans allow for the amortization of gains and losses.
So if you have a sizeable loss on your investment portfolio inside your pension plan, that doesn't hit your bottom line all in one year—it’s spread out over the future service of your employees.
While the continued low interest rates that credit union pensions are required to use to value liabilities also are a concern, the Federal Reserve Board appears committed to increasing those rates. That may lower the cost of pension plans.
Two common misperceptions
There are two common misperceptions about pre-funding credit union DB pension plans:
1. Across industries, current funding rules consider plans funded at 70% to 80% of future obligations to be “fully funded,” so credit unions don’t need to fund plans beyond that.
One problem with this theory is that DB plan liabilities—the projected future payouts—can change rapidly.
Future benefit obligations may increase unexpectedly if there are higher-than-expected salary increases or if you hire older, higher-paid employees, for example.
Rather than having to respond to such increases by reducing benefits, freezing the plan, or even ending it, pre-funding the plan gives your credit union better options.
Credit unions are one of only a few entities in which it makes sense to exceed 100% funding—so use this to your advantage.
2. Sinking excess liquidity into pre-funding a DB plan will hit the income statement too hard.
Cash contributed to a pension plan is not recorded as an expense; it either increases an existing pension asset or decreases an existing pension liability.
The difference between your DB plans’ assets and liabilities stays on your balance sheet as an asset. It’s not a hit to your bottom line.
The idea is to put that money where it can earn better returns, rather than parking it in short-term Treasuries, which currently pay next to nothing.
Credit unions are allowed to invest DB pension funds in investments that otherwise are impermissible, including some mutual funds, commercial bonds, exchange traded funds, and individual securities.
If your credit union has a DB pension plan, chances are it was established by executives and board members who are now long retired.
As these plans have declined in the private sector nationwide, fewer new credit union leaders are likely to have expertise in administering them.
But DB plans remain an excellent benefit and an efficient way to ensure your retirees can replace a target percentage of their working income. This is a strong competitive advantage in recruiting and retaining good talent.
Pre-funding can keep your DB plan viable by reducing costs and expanding investment opportunities for credit union assets.
KEN NEWHOUSE is director of enrolled actuary services for CUNA Mutual Retirement Solutions.