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5500 Preparer's Manual for 2012 Plan Years

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CCH® PENSION AND BENEFITS — 1/18/08

Proposed cash balance/hybrid plan regs issued by IRS

The IRS has issued proposed regulations on hybrid defined benefit plans, such as cash balance plans, incorporating and expanding upon the transitional guidance of Notice 2007-6 (CCH Pension Plan Guide 17,135Q ) following the passage of the Pension Protection Act of 2006 (PPA; P.L. 109-280).

Special vesting rules

Under the proposed regulations, a plan would not violate rules regarding a participant’s accrued benefit derived from employer contributions merely because the plan determines the present value of benefits under a lump sum-based benefit formula as the amount of the hypothetical account maintained for the participant, or as the current value of the accumulated percentage of the participant’s final average compensation under that formula.

The proposed regulations introduce certain new terminology. “Accrued benefits to date,” under Code Sec. 411(b)(5) , are referred to in the proposed regulations as the “accumulated benefit.” This is distinct from the participant’s accrued benefit under Code Sec. 411(a)(7) , which is an annuity beginning at normal retirement age that is actuarially equivalent to the participant’s accumulated benefit.

Under the proposed regulations, whether a benefit formula is a “lump sum-based benefit formula,” used to determine a participant’s accumulated benefit would be determined based on how the participant’s accumulated benefit is expressed under the terms of the plan, and not on whether the plan provides an optional form of benefit in the form of a single sum payment. Similarly, a formula would not fail to be a lump sum-based benefit formula merely because the plan’s terms state that the accrued benefit is an annuity at normal retirement age that is actuarially equivalent to a hypothetical account balance.

Another new term used by the proposed regulations is “statutory hybrid benefit formula.” This term is defined as a benefit formula that is either a lump sum-based benefit formula or a formula that has an effect similar to a lump sum-based benefit formula, such as one providing that a participant’s accrued benefit payable at normal retirement age is expressed as a benefit which includes periodic adjustments expected to result in a larger annual benefit at normal retirement age when compared to a similarly situated, younger individual in the plan. The proposed regulations also provide that, in the case of a participant whose accrued benefit is determined under a statutory hybrid benefit formula, the plan must give the participant a nonforfeitable right to 100% of his accrued benefit if the participant has three or more years of service.

Age discrimination safe harbor

The proposed regulations provide for a safe harbor from age discrimination claims if a participant’s accumulated benefit expressed under any benefit formula would not be less than any similarly situated, younger participant’s accumulated benefit expressed under the same formula. The safe harbor standard would be available only where a participant’s accumulated benefit under the terms of the plan is expressed as an annuity payable at normal retirement age, the balance of a hypothetical account, or the current value of the accumulated percentage of the employee’s final average compensation.

The proposed regulations require a comparison of the accumulated benefit of each possible participant in the plan to the accumulated benefit of each other similarly situated, younger individual who is or could be a participant in the plan. The comparison must be made using the same form of benefit; for instance, the accumulated benefit of a participant expressed as an annuity at normal retirement age cannot be compared to the accumulated benefit of a similarly situated, younger participant expressed as a hypothetical account balance.

Conversions

Under the proposed regulations, a participant whose benefits are affected by a conversion amendment which occurred after June 29, 2005, must generally be provided with a benefi t after the conversion that is at least equal to the sum of the benefits accrued through the date of the conversion and benefits earned after the conversion, with no permitted interaction between these two portions. This is intended to assure participants that no “wear-away” results from the conversion.

There is also an alternative method under which the plan may provide for the establishment of an opening hypothetical account balance as part of the conversion, keeping separate track of the opening hypothetical account balance and the post-conversion hypothetical contributions.

Under the proposed regulations, whether an amendment is a conversion amendment is determined on a participant-by-participant basis. If a) the amendment reduces or eliminates the benefits that, but for the amendment, the participant would have accrued after the effective date of the amendment under a benefit formula that is not a statutory hybrid benefit formula and under which the participant was accruing benefits prior to the amendment, and b) after the effective date of the amendment, all or part of the participant’s benefit accruals under the plan are determined under a statutory hybrid benefit formula, then the amendment would be considered a conversion amendment with respect to that participant.

The proposed regulations provide that a conversion amendment also includes multiple amendments that result in a conversion amendment, even if the amendments would not be conversion amendments individually. The proposed regulations also prohibit the avoidance of the conversion protections through the use of multiple plans or multiple employers.

Market rate of return

The proposed regulations reflect the rule that a statutory hybrid plan may not provide an interest crediting rate which is in excess of a market rate of return. The proposed regulations define an “interest crediting rate” as the rate by which a participant’s benefit is increased under the ongoing terms of a plan to the extent the amount of the increase is not conditioned on current service, without regard to whether the amount is calculated by reference to a rate of interest, a rate of return, an index, or otherwise.

The proposed regulations require a plan to specify the timing for determining the plan’s interest crediting rate for each plan year by one of two permitted methods: pursuant to a daily interest crediting rate based on permissible interest crediting rates specified in the proposed regulations, or pursuant to a specified lookback month and stability period.

An interest crediting rate for a plan year is not in excess of a market rate of return, under the proposed regulations, as long as it is based on specified safe-harbor indices: 30-year Treasury rates and long-term corporate bonds, for plan years beginning before January 1, 2008, and the third-segment bond rates, for subsequent years. These rules are similar to those in Notice 2007-6, the IRS notes, but omit guidance on a number of issues related to market rate of return. The IRS expects to address these issues in the first part of 2008.

The IRS notes that Code Sec. 411(b)(5)(B)(i)(I) provides that a statutory hybrid plan is not treated as having an above-market rate merely because the plan provides for a reasonable minimum guaranteed rate of return or for a rate of return that is equal to the greater of a fixed or variable rate of return. However, the proposed regulations do not provide guidance in this regard.

The IRS is concerned that the use of a minimum guaranteed rate of return or the use of the greater of a fixed and a variable rate could result in effective interest crediting rates that are above market rates of return. The IRS is therefore interested in comments on how to avoid that result. Comments are also requested on what other asset portfolios are sufficiently lacking in volatility so as to permit them to form the basis of a market rate of return for interest crediting under a statutory hybrid plan. Pending issuance of guidance addressing these and related issues, the IRS advises plan sponsors to be cautious in adopting interest crediting rates other than those explicitly permitted in these proposed regulations.

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