Hybrid (Cash Balance/Pension Equity) Plan Regulations: Market Rate Amendments

In October the IRS released regulations, in final and proposed form, intended to provide clarity in the utterly complicated area of hybrid pension plans, the two most common of which are cash balance plans and pension equity plans. These new regulations address:

• “market rate” of return limits for interest credits;
• anti-wear away protections for cash balance plan conversions;
• relief from the requirement to perform “whipsaw” calculations in determining lump sum distributions;
• benefit designs that satisfy age discrimination rules;
• three-year mandatory vesting; and
• new definitions and effective dates for conversion amendments.

The final regulations are generally effective for plan years beginning on or after January 1, 2011, but the proposed market rate of return standard is delayed for one year (plan sponsors may rely on this and other prior guidance before then). Sponsors of cash balance and other hybrid plans should consult plan actuaries or legal advisors to determine how these new regulations impact their plans.

Sponsors of hybrid plans with interest credits that may exceed proposed market rates generally seem to be aware they may have to amend their plans, but may be curious about timing for adoption of such an amendment.

Under rules for cash balance and other hybrid plans enacted in the Pension Protection Act of 2006 (Pub. L. No. 109-280), a plan is deemed noncompliant with age discrimination rules if it provides interest credits based on a rate that exceeds a market rate of return. Final regulations list variable bond-based rates that a plan may use as a market rate, as well cost-of-living indices under the required minimum distribution rules increased by as much as 300 basis points. The proposed regulations would allow an equity-based market rate of return on aggregate plan assets or a rate of return on certain mutual funds, although single industry funds and non-U.S. based funds generally are excluded. The proposed regulations also would permit the use of a fixed rate that does not exceed five percent, an annual fixed-rate floor of up to four percent (if used with a permitted bond-based rate), and a cumulative fixed-rate floor of up to three percent if used with a permissible equity-based rate.

For plans that happen to specify rates for interest credits that are considered above-market under the new rules, plan sponsors may need to adopt plan amendments to conform to a market rate. We expect sponsors to await final market rate regulations prior to adopting such amendments, to allow evaluation of available options and, in no small part, because the Treasury Department and IRS have indicated they expect to provide cutback relief for such amendments, although such relief does not exist at the present time. (In general, required plan amendments must be adopted by the date of the employer’s tax return for the year first takes effect or, for an amendment that reduces future benefits, before the beginning of the first plan year in which the reduction applies.) The rulemaking process may be tracked online (Keyword: IRS REG-132554-08).