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CCH's Law, Explanation and Analysis of Health Care Reform Legislation
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The IRS has issued proposed regulations that refine and extend defined benefit (DB) plan accrual rules for plans with two or more benefit accrual formulas, such as converted cash balance plans. The proposed rules provide a limited exception to the requirement to aggregate accrued benefits under all statutorily prescribed benefit accrual formulas.
Under the minimum vesting standards of Code Sec. 411(a), a trust will not be a qualified trust unless it provides that an employee’s right to his normal retirement benefit is nonforfeitable upon the attainment of normal retirement age and satisfies the accrued benefit requirements of Code Sec. 411(b) , among other requirements.
Code Sec. 411(a)(7)(A)(i) defines a participant’s accrued benefit under a defined benefit plan as the employee’s accrued benefit determined under the plan, expressed in the form of an annual benefit commencing at normal retirement age. An exception in Code Sec. 411(c)(3) provides that if a plan that does not express an employee’s accrued benefit as an annual benefit commencing at normal retirement age, the accrued benefit shall be expressed as the actuarial equivalent of the annual benefit commencing at normal retirement age. For such plans, Reg. §1.411(b)-1(a)(1) provides that a defined benefit plan is not a qualified plan unless the method provided by the plan for determining accrued benefits satisfies at least one of the alternative methods specified in Reg. §1.411(b)-1(b) for determining accrued benefits with respect to all active participants in the plan.
The three alternate benefit accrual methods are:
A defined benefit plan may provide that accrued benefits for participants are determined under more than one plan formula, such as in plans that have pre- and post-ERISA accruals or in cash balance plan conversions. Plan benefits are then determined on the basis of the greatest of two or more formulas. In this case, Reg. §1.411(b)-1(a)(1) provides that the accrued benefits under all such formulas must be aggregated in order to determine whether or not the accrued benefits under the plan satisfy one of the methods listed above. Under Reg. §1.411(b)1(a)(1) , a plan may satisfy different methods with respect to different classifications of employees, or separately satisfy one method with respect to the accrued benefits for each such classification, provided that such classifications are not so structured as to evade the accrued benefit requirements of Code Sec. 411(b) and Reg. §1.411(b)-1 .
Rev. Rul. 2008-7 (CCH Pension Plan Guide ¶19,948Z-220) applies the alternate accrual rules above to a defined benefit plan that was amended to change the plan’s benefit formula from a traditional formula based on highest average compensation to a new lump sum-based formula. Although the guidance in Rev. Rul. 2008-7 is useful, its applicability is limited to plan years beginning before 2009. In addition, the relief provided to plans in Rev. Rul. 2008-7 does not apply to the parallel accrual rules of ERISA §204(b)(1) (A), (B), and (C).
The proposed regulations would provide a limited exception to the existing requirement under Reg. §1.411(b)-1(a)(1) to aggregate the accrued benefits under all formulas in order to determine whether or not the accrued benefits under the plan for participants satisfy one of the alternative methods under Code Sec. 411(b)(1) (A) through (C). Under this limited exception, certain plans that determine a participant’s benefits as the greatest of the benefits determined under two or more separate formulas would be permitted to demonstrate satisfaction of the 133 1/3 percent rule of Code Sec. 411(b)(1)(B) by demonstrating that each separate formula satisfies the 133 1/3 percent rule of Code Sec. 411(b)(1)(B) .
A plan would be eligible for this exception only if each of the separate formulas uses a different basis for determining benefits. For example, a plan would be eligible for this special rule if it provides a benefit equal to the greater of the benefits under two formulas, one of which determines benefits on the basis of highest average compensation and the other of which determines benefits on the basis of career average compensation. Similarly, a traditional defined benefit plan which determined benefits based on highest average compensation that is amended to add a cash balance formula (as in the facts of Rev. Rul. 2008-7) would be eligible for this exception where, in order to provide a better transition for longer service active participants, the plan provides that a group of participants is entitled to the greater of the benefit provided by the hypothetical account balance and the benefit determined under the continuing traditional formula. This plan would be permitted to utilize the exception because each separate formula under the plan uses a different basis for determining benefits.
The proposed regulations would also provide an extension of this exception in the case of a plan that provides benefits based on the greatest of three or more benefit formulas. In such case, the plan would be eligible for a modified version of the formula-by-formula testing under the proposed regulations. Under this modification, the accrued benefits determined under all benefit formulas that have the same basis are first aggregated and then those aggregated formulas are treated as a single formula for purposes of applying the separate testing rule under the proposed regulations.
Eligibility for separate testing under the proposed regulations would be constrained by an anti-abuse rule. The proposed regulations would provide that a plan is not eligible for separate testing if the Commissioner determines that the plan’s use of separate formulas with different bases is structured to evade the general requirement to aggregate formulas under Reg. §1.411(b)-1(a)(1) . This consideration would apply, for example, if the differences between the bases of the separate formulas are minor.
The rules are proposed to be effective for plan years beginning on or after January 1, 2009. A public hearing has been scheduled for October 15, 2008. Those wishing to make public comments or speak at the hearing must submit their comments by September 16, 2008.
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