The Tax Advantages of Pension Fund Investments in Bonds

Fischer Black

NBER Working Paper No. 533
Issued in August 1980
NBER Program(s):Public Economics

I believe that every tax-paying firm's defined benefit pension fund portfolio should be invested entirely in bonds (or insurance contracts). Although the firm's pension funds are legally distinct from the firm, there is a close tie between the performance of the pension fund investments and the firm's cash flows. Sooner or later, gains or losses In pension fund portfolios will mean changes in the firm's pension contributions. Shifting from stocks to bonds in the pension funds will increase the firm's debt capacity, because it will reduce the volatility of the firm's future cash flows. Shifting from stocks to bonds in the pension funds will give an indirect tax benefit equal to the firm's marginal tax rate times the interest on the bonds. There is no indirect tax benefit if the pension funds are invested in stocks. Fully implementing the plan will mean shifting all of the stocks in the pension fund to fixed income investments, and putting all new contributions into fixed income investments. Shifting $2 million from stocks to bonds has a present value for the firm's stockholders of about $1 million. Shifting from stocks to bonds in the pension funds will reduce the firm's leverage. To offset this, the firm can issue more debt than it otherwise would have issued. The money raised can be invested in the firm or used to buy back the firm's stock. This version of the plan, with more bonds in the pension fund and more debt on the firm's balance sheet, is equivalent to the following transactions: (1)sell a portfolio of stocks on which no taxes are paid, and buy the firm's stock on which no taxes are paid; and (2) issue the firm's bonds at an after-tax interest rate, and buy other firm's bonds at a before-tax interest rate.

download in pdf format
   (420 K)

email paper

Machine-readable bibliographic record - MARC, RIS, BibTeX

Document Object Identifier (DOI): 10.3386/w0533

Published: Black, Fischer. "The Tax Consequences of Long-Run Pension Policy." Financial Analysts Journal, Vol. 36, (July/August 1980), pp. 21-28.

Users who downloaded this paper also downloaded* these:
Tepper w0661 Taxation and Corporate Pension Policy
Bodie w2752 Pension Fund Investment Policy
Harrison and Sharpe Optimal Funding and Asset Allocation Rules for Defined-Benefit Pension Plans
Bodie, Light, and Morck Funding and Asset Allocation in Corporate Pension Plans: An Empirical Investigation
Feldstein Private Pensions as Corporate Debt
NBER Videos

National Bureau of Economic Research, 1050 Massachusetts Ave., Cambridge, MA 02138; 617-868-3900; email:

Contact Us