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CHARLOTTE, N.C. -- New legal questions are dogging NationsBank Corp.'s innovative participant-directed cash balance pension plan.
Employee benefit and legal experts are questioning how the company's new approach fits with certain Internal Revenue Service rules governing the transfer of funds between defined contribution and defined benefit plans. Charlotte, N.C.-based NationsBank, which now operates under the name Bank of America following its merger with BankAmerica Corp., has refused to discuss the plan (BI, Oct. 5).
"Legal issues have to be addressed in such arrangements," said Fred Rumack, director of taxes and legal services at Buck Consultants Inc. in New York.
The NationsBank plan allows employees to direct the investment of company-provided cash balance plan pay credits. Employees can choose among 11 investment options, including fixed income and various equity funds. Employees' cash balance plan accounts then are credited with the actual returns of the funds they select.
In addition, employees had a one-time opportunity -- available through June 28 -- to transfer to the cash balance plan any pretax contributions they previously had made to the 401(k) plan and to allocate those 401(k) monies among the 11 investment options.
Regardless of the investment options selected, NationsBank guarantees employees' cash balance pay credits, the funds they transferred from their 401(k) plans and the gains earned by the funds into which they directed their pay credits.
Even if the investment funds an employee selects have negative investment returns, the value of an employee's account balance will not be reduced below the level before investments were made.
Employees' account balances, though, exist only on paper. Legally, cash balance plans are defined benefit plans in which NationsBank and its professional advisers decide how to invest plan assets. The bank is not required to direct pension plan investments to match employees' selections or to credit employees' account balances with the actual returns NationsBank achieves.
While NationsBank's plan is undoubtedly innovative, some benefit experts aren't sure how the design -- specifically the transfer of 401(k) monies to the cash balance plan -- complies with certain IRS regulations.
Those regulations involve Section 411(d)(6) of the Internal Revenue Code. Among other things, the regulations say that when funds are moved from defined benefit plans to defined contribution plans, or vice versa, certain rights and features of the plan from which funds are moved are "protected" and cannot be taken away.
Among other things, the regulations stipulate that the separate employee account feature of a defined contribution plan, like a 401(k) plan, is a protected feature and must be preserved.
However, funds can be transferred between defined contribution and defined benefit plans -- without violating Section 411(d)(6) -- if the funds are available for distribution to employees. For example, an employee who retires and wants to transfer a 401(k) account balance to his or her employer's defined benefit plan could do so without violating the IRS regulation, because the employee would have a right to take the entire 401(k) account balance.
However, in a situation where an employee continues to work for the same employer, full distributions of 401(k) account balances are not allowed.
Given the IRS requirements -- protection of separate defined contribution plan account balances for each employee -- some benefit experts are puzzled that NationsBank's approach, in which employees could transfer funds to the cash balance plan from their 401(k) accounts, passed IRS muster. That's because cash balance plans have hypothetical account balances but in fact do not have the actual individual account feature of 401(k) plans.
"A cash balance plan account may look like a separate" defined contribution plan account, but it is not, Mr. Rumack said. In a defined contribution plan, like a 401(k) plan, investment earnings must be distributed to employees' accounts. In a cash balance plan, investment earnings belong to the actual plan, he noted.
Some benefit experts say the IRS may have approved the plan because, while it possibly does not fit the exact letter of regulations, in spirit it may be close.
"Can NationsBank say, 'We have not taken away a right. . .as long as employees have the same opportunity to choose investment options, we have not taken something away.' Perhaps that is a logical argument," said Paul Strella, an attorney with William M. Mercer Inc. in Washington.
Others note that regulations -- drafted a decade ago and intended to interpret legislation Congress passed -- cannot possibly address all plan designs that have since evolved. That can lead IRS staffers to take positions on which there is little background.
"Legally, this plan raises novel questions. There are no open-and-shut answers," said Richard Shea, a partner with Covington & Burling in Washington.
Mr. Shea noted that it is neither possible nor desirable for Con-gress to write detailed rules for every new pension plan design. "Regulators exercise discretion to interpret law. The trick to doing a good job is to interpret the law in a way that makes sense and is true to its spirit," he said.
"Do you automatically say 'no' to a new plan design merely because it was not around when Congress last visited this subject?" Mr. Shea asked.
"Personally, I think, it is possible for a cash balance plan to preserve the separate account feature of a defined contribution plan and add desirable features to it, like investment protection," Mr. Shea said.
Others, though, say that without having access to all details of the transaction, it is impossible to know precisely what legal mechanism NationsBank used to implement the program.
But a benefit consultant who asked not to be identified questioned if the IRS agent understood all the 411(d)(6) issues involved before approving the plan.
"This is a cutting-edge design. It is possible these issues went right by the agent," the consultant said, adding that he wouldn't be surprised if the publicity generated by the plan leads the IRS National Office to intervene and review the plan.
"This plan did not receive the scrutiny it should have," another consultant added.
The IRS declined to comment.
While the design is generating controversy, some benefit experts say that, from an employee perspective, NationsBank's approach combines the best features of defined contribution and defined benefit plans.
"I think it is a great idea. Participants have investment choices, and they have protections against a down market," Mr. Shea said.
"This is a striking example of plan flexibility," added Dave Wolfe, a partner with Gardner, Carton & Douglas in Chicago.
Other benefit experts, though, have noted that the benefit guarantees could cost NationsBank dearly if employees choose investment options that decrease sharp-ly in value.
"The theory is that an employer will earn more than participants' investment choices. I think that will be difficult," said Bob Howley, a Buck Consultants actuary in New York.