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IRS to resume approving hybrid pension plan conversions

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WASHINGTON—The Internal Revenue Service's decision to resume processing cash balance pension plan conversion applications may encourage more employers to offer cash balance and other hybrid pension plans, experts say.

The IRS is lifting a seven-year-old moratorium on determination letter applications for conversions from traditional defined benefit plans to cash balance plans, as well as providing interim guidance on provisions of the Pension Protection Act of 2006 involving cash balance plans.

In 1999, the IRS suspended processing of determination letter applications pending study of the issues raised by conversions to cash balance plans, including the impact of such conversions on older employees. A determination letter is a kind of government seal of approval.

With the passage of the Pension Protection Act, though, the IRS said in Internal Revenue Notice 2007-6 that it can now resume processing the backlog of about 1,200 cash balance plan applications that were affected by the moratorium. The agency hopes to resolve a significant majority of these cases by the end of 2007.

The PPA, among other things, made clear that new cash balance plans will be considered non-age discriminatory so long as they meet certain standards.

Although the IRS will once again begin processing determination letter requests, the agency made a distinction between conversions occurring before June 30, 2005, which is the retroactive effective date of the PPA's cash balance plan provisions. For conversions prior to that date, the determination letter will not address whether the plan meets the new legislative requirements, while it will certify whether plans converting after that date meet the requirements, said Jan Jacobson, director of retirement policy at the American Benefits Council in Washington.

For example, the PPA does not permit wearaway, a situation where employees in plans that convert to a cash balance design may not accrue benefits for years due to interest rate fluctuations in the new plan formula. Cash balance opponents cited wearaway as a disadvantage of the plans. But the PPA requires plans that convert to a cash balance design to allow employees to receive benefits based on the old formula until the date of conversion and benefits based on the new formula after that date.

In its determination letters, the IRS would address whether a converted plan complies with the wearaway prohibition for plans that converted after the retroactive date, but would not do so for plan conversions prior to the retroactive date, Ms. Jacobson said.

The PPA's legitimization of cash balance plans combined with the 7th U.S. Circuit Court of Appeals ruling in August that found that IBM Corp.'s cash balance plan in particular and cash balance plans in general are not age discriminatory and the IRS' lifting of the moratorium on issuing determination letters, should remove much of the uncertainty surrounding cash balance plans and "give another option to employers that might terminate or freeze a defined benefit plan without replacing it with anything on the defined benefit side," Ms. Jacobson said.

Interim guidance on the PPA's provisions is also helpful, even though additional guidance, which the agency plans to issue this year after a comment period that ends April 16, is needed, pension experts say.

"I think it does clear the way for companies considering the plans to move forward," said Larry Sher, a principal and director of retirement policy at Buck Consultants L.L.C. in New York.

A favorable feature of the interim guidance for plan sponsors is that they will be able to remove any whipsaw provisions going forward and pay lump sums equal to the account balance to cash balance participants without worrying about an impermissible reduction of accrued benefits, Mr. Sher said.

The IRS did not issue guidance, though, on how whipsaw issues would be handled for prior-year periods, he noted. Whipsaw refers to a methodology used in calculating the value of an account balance that may have entitled employees to a sum greater than his or her account balance depending on the interest rate assumptions applied.