Why The Yield Curve Is Flat & Why It May Steepen

We will offer readers a few references so they can become quick studies on why certain changes in the tax code are distorting the shape of the yield curve (flattening it) and why that distorting effect will change in about six weeks.

The first link is to BDO. It describes the defined-benefit pension plan funding issue that applies. https://www.bdo.com/insights/assurance/employee-benefit-plan-audits/carpe-diem!-accelerating-defined-benefit-funding-t.

Now here’s Deloitte on this subject. https://www2.deloitte.com/content/dam/Deloitte/us/Documents/Tax/us-tax-considerations-for-accelerating-deductions-for-qualified-retirement-plans.pdf.

Let’s try this in English.

If you are a corporation and have an unfunded defined-benefit pension liability, and you fund it before September 15, you can take the tax deduction at the old 35% corporate income tax rate. After September 15, that deduction rate drops to 21%. Obviously, if you know your liability and/or can estimate it, you can fund now whether you have the cash or must borrow it. By doing so, you save 14% of the payment you might otherwise have to make.

The next incentive is the fact that if you are underfunded, your Pension Benefit Guarantee Corporation (PBGC) underfunded penalty rate will be rising next year. So funding now saves you a future and rising cost while it also absolutely saves you tax dollars.

Last, another incentive is that, when you improve your funding ratio, your penalty rate assessed by PBGC goes down.

So what happens to the money once you fund it? By using Treasury strips (a zero-coupon, compounding US Treasury obligation that is financially engineered by dealers from longer-term US Treasury notes and bonds) you can lock up the funding of your long-term pension liabilities. When you do, your creditworthiness according to rating agencies goes up, and your funding ratio is more secure. Fixed-rate instruments are treated differently from variable-rate assets (stocks) when PBGC determines underfunding penalties.