Heading for the cliff

Without Congressional action by December 31, a series of tax cuts will expire, and automatic spending cuts will kick in. After a contentious election, the big question now is: Will the debt discussion be different this time? Will there be more political brinkmanship or has the tone shifted enough to allow for bipartisan cooperation? More importantly for our readers here: What will the outcome of the fiscal cliff negotiations mean for retirement plans if the fiscal cliff isn’t addressed before December 31?

The first day after the election, the Dow lost over 300 points, its largest one day loss in over a year. During the deliberations to raise the debt ceiling, the stock market was extremely volatile. With this backdrop, more stock market volatility is entirely possible. If we experience a drop in the stock market between now and December 31, the asset values for all retirement plans will be down. This will affect savings plans, IRAs, and pension plans.

Milliman’s November 2012 Pension Funding Index showed a pension funding deficit of $498 billion. If the fiscal cliff is not addressed in a timely manner, this deficit could get worse. In order to illustrate the possible implications for pension plans, we used the latest Milliman Pension Funding Index and assumed an equity decline of 20% in December. If such a scenario plays out it will lead to a record low in pension funded status.

Unless interest rates rise, corporate pension plan sponsors who measure their liabilities based on the current level of interest rates will continue to use historically low interest rates. This means their plan liabilities will remain at high levels, a hit to the corporate balance sheet, which is due to the pension plan’s funded status and an increase in contributions for the 2013 plan year.

For public pension plan sponsors, this will likely mean higher contribution rates for the 2013 plan year. For those pension plan sponsors who do not measure their assets and liabilities on December 31, it’s a matter of wait and see what happens until they check in next.

Interesting times indeed.

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