WASHINGTON-New guidance on interest credits for cash balance plans proposed by the Internal Revenue Service will not result in major plan redesigns for employers, benefit consultants say.

The proposed regulations, released earlier this month, mark the second time the IRS has issued guidance on cash balance plans, which have increased in popularity among employers, especially those wanting to replace traditional defined benefit plans. The IRS issued non-discrimination testing rules for cash balance plans under section 401(a)(4) in 1991.

"There has been lots of talk, some speculation and in some cases concern over what restrictions will be placed on these plans," said Larry Sher, principal with Kwasha Lipton L.L.C. in Fort Lee, N.J. "They've set up a structure that is workable and acceptable for many people."

In the future, Mr. Sher said, guidance will get progressively better and will provide more clarity. This will "lead to employers feeling more secure about the plans, and lead other employers sitting on the sideline waiting for more clarification of what they can and can't do with the plans to jump into these," he predicts.

"These regulations are about one-fifth of the regulations people have been waiting for," said Mike Johnston, actuary and principal for Hewitt Associates L.L.C. in Lincolnshire, Ill. There are still many other defined benefit issues that need clarification. However, "a lot of plans will fall under the proposed guidelines" and with few exceptions, there won't be many "out and out design changes."

While cash balance plans are defined benefit plans, they include many features of defined contribution plans, like individual account balances and benefit portability. Account balances are credited with employer allocations based on a percentage of compensation and interest credits. Interest credits are typically determined using an interest rate or rate of return under a variable outside index, such as the one-year Treasury bill rate, plus 1%.

Until now, there has been no guidance on how to determine the interest credits employers should use for accruing account balances.

Employers can run into possible plan violations when distributing lump sum payouts to employees leaving the company, when the interest rate component used is larger than the 30-year Treasury bond rate, which, under the Retirement Protection Act of 1994, is the standard index to use when determining the present value of an account.

If the interest credit offered by an employer is larger than the 30-year Treasury bond rate, the present value of the employee's accrued benefit will generally exceed the original account balance. If this happens, the employee would receive a lump sum that is less than the amount the employee is entitled to and the plan would be in violation.

In determining the proposed indices, the IRS

took into account the historical relationship between each index and the 30-year Treasury interest rate standard and assumes that they will not exceed the standard.

The proposed standard indices are:

The discount rate on 3-month Treasury bills, plus 1.75%.

The discount rate on 6-month or 12-month Treasury bills, plus 1.5%.

The yield on 1-year Treasury Constant Maturities, plus 1%.

The yield on 2-year or 3-year Treasury Constant Maturities, plus 0.5%.

The yield on 5-year or 7-year Treasury Constant Maturities, plus 0.25%.

The yield on 10-year Treasury Constant Maturities or any longer period Treasury Constant Maturities, plus 0%.

Annual rate of change of the Consumer Price Index, plus 3%.

Consultants say most employers are already using one of these options to determine their interest credits. However, employers that have opted to use a non-fluctuating interest credit, such as a flat 5% rate increase, will have to redesign their plans to comply with the regulations, Hewitt's Mr. Johnston said.

For those employers that have interest credits currently in violation of the proposed regulation, benefit consultants say they believe the government will give some sort of relief or reprieve to employers.

Going forward, employers will have to comply, going backward, "I think the proposed rules say as long as you did something that was reasonably in good faith and is based on interpretation of rules that can be supported, the IRS will not audit cash balance plan payouts from three years ago," Mr. Johnston said.

"I anticipate the protection of existing plans to be somewhat liberal because there was no guidance before," agreed Fred Rumack, director of tax and legal services for Buck Consultants Inc. in New York.

"The IRS doesn't want to disqualify these plans," Mr. Rumack said.