Help

BI’s Article search uses Boolean search capabilities. If you are not familiar with these principles, here are some quick tips.

To search specifically for more than one word, put the search term in quotation marks. For example, “workers compensation”. This will limit your search to that combination of words.

To search for a combination of terms, use quotations and the & symbol. For example, “hurricane” & “loss”.

Login Register Subscribe

IRS rules add clarity for cash balance plan sponsors

Agency also removes concerns about age discrimination

Reprints

WASHINGTON—Proposed and final Internal Revenue Service rules released last week are likely to give a modest boost to cash balance pension plans, experts say.

The proposed rules end years of uncertainty created by a 2006 pension law that allows plan sponsors to use a “market rate” to credit interest to participants' account balances. The IRS had not provided definitive guidance on what would be considered a market rate until last week.

The proposed regulations are to take effect on Jan. 1, 2012, but employers can rely on this interim guidance.

“Through very simple statements in the regulations, the uncertainty has been eliminated,” said Alan Glickstein, a senior consultant with Towers Watson & Co. in Dallas.

Under the proposal, employers that use a fixed percent to credit interest to participants' cash balance accounts would have a rate cap of 5% a year. Cash balance plans provide an accumulated benefit that is based on pay-related and interest credits and is expressed as cash lump sum.

In addition, for employers that use a design formula that credits the greater of either the interest rate on certain bond-based indices or a fixed percentage, the fixed percentage cannot exceed 4%.

For employers that use a design in which the interest credit is linked to an equity-based rate, the interest credit could be either the rate of return earned by the equity index or a certain percentage, whichever is greater, up to 3% cumulatively.

Take the case of an employee who enrolled in a plan with such an indexing feature and a 3% interest credit guarantee. The employee retired after five years. The employee's account balance would be the greater of the amount based on the results of the equity fund index or the amount based on crediting 3% interest to the account balance each year.

Few employers now use such an approach.

On a related front, the IRS last week also released final rules that largely affirm cash balance plan rules proposed by the IRS in 2007.

For example, one provision involves vesting of accrued benefits. Under the 2006 law, the Pension Protection Act, participants' cash balance accounts must be fully vested after three years of participating in the plan.

Employers, though, weren't sure how the provision would apply to other plans with longer vesting schedules if those plans were converted to cash balance plans. Typically, final average pay plans—the most common type of defined benefit plan—offer full vesting after five years of service. In such conversions, the three-year full vesting requirement would apply to employees who earn benefits under both designs.

Like the proposed rules, the final rules also make clear that a cash balance plan participant never can receive less than the pay-related credits he or she has earned. That requirement would apply most directly when the interest credit is tied to the rate of return on an equities fund, which then earns a negative return.

The final rules also retain numerous safe harbors, such as employers crediting interest to employees' account balances based on U.S. Treasury note and bond rates.

In addition, the rules also make clear that the basic design of cash balance plans is not age discriminatory, which was congressional intent when legislators wrote the 2006 law.

Prior to the PPA, numerous lawsuits were filed against cash balance plan sponsors challenging the design because younger employees would receive interest credits for more years than older employees. However, five federal appeals courts all rejected the age discrimination allegations.

“The regulations are one more piece of weight” on the age discrimination issue, said Doug German, chief actuary-retirement with Buck Consultants L.L.C. in St. Louis.

Plans will not be considered age discriminatory as long as pay credits do not decrease with age, said Eric Keener, a senior consultant with Aon Hewitt Inc. in Norwalk, Conn.

By providing definitive guidance, especially in defining a market rate of interest, the regulations likely will encourage more employers with the plans to keep them.

The IRS “has provided certainty in some key areas that will give enough comfort to some cash balance plan sponsors so they may stay in the game,” said Ethan Kra, chief actuary for Mercer L.L.C. in New York.

For prospective cash balance plan sponsors, “you have a road map and can design your plan and move on,” Mr. Kra added.

“Most of the uncertainties that have been a deterrent to establishing new plans have been eliminated,” said Jeff Davis, a managing director with PricewaterhouseCoopers L.L.P. in Washington.

Still, amid the multiyear march by employers away from defined benefit to defined contribution plans, which have more predictable costs and shift investment risk to employees, experts said the IRS rules will result in only modest plan growth, not a surge of new cash balance plans.

Hundreds of such plans are offered by larger employers, though a chunk of them, as is the case with traditional plans, have been partially frozen, with the plans closed off to new employees. In other cases, employers have completely frozen the plans with current employees not earning new benefits.

The plans blossomed as they were attractive to employers looking to make pension benefits more visible and easy to understand for employees. The plans also appealed to mobile workforces, because they provide a more rapid buildup of benefits than traditional final average pay plans.

But plan formation ground to a halt after a wave of suits were filed in the late 1990s, charging that the plan design was age discriminatory.

While the PPA and courts ended the age discrimination issue, only about a dozen large employers—including Coca-Cola Co. in Atlanta and Dow Chemical Co. in Midland, Mich.—have set up cash balance plans since the passage of the PPA.

There has been greater interest in the plans among smaller employers that are attracted by arrangements that can provide greater benefits to top executives than defined contribution plans, consultants say.

Employers can submit comments on the proposed regulations, which were published the Oct. 22 Federal Register.