The Internal Revenue Service (IRS) issued final regulations relating to hybrid retirement plans, including cash balance plans and pension equity plans. The IRS also issued proposed regulations providing anti-cutback relief under IRC Section 411(d)(6) so that plans may be amended to comply with the guidance.
On September 18, 2014, the Internal Revenue Service (IRS) released proposed (26 C.F.R. § 1.411(b)(5)–1) and final (26 C.F.R. § 1.411(a)(13)–1) regulations relating to hybrid retirement plans, such as cash balance plans and pension equity plans. The final regulations provide guidance on certain issues under IRC Sections 411(a)(13) and 411(b)(5) that were not addressed in the 2010 final regulations and make other changes to those sections. The proposed regulations issued in connection with the final regulations provide anti-cutback relief under IRC Section 411(d)(6) so that plans may be amended to comply with the guidance without violating the anti-cutback rules.
Hybrid Plans: Background
Hybrid defined benefit plans, such as cash balance plans or pension equity plans (PEP), combine features of bothdefined contribution anddefined benefit plans. In a hybrid plan, the participant's accumulated benefit is usually expressed as:
The current balance of a hypothetical account maintained for the participant.
The current value of an accumulated percentage of the participant's final average compensation.
In 2010, the IRS issued proposed (75 FR 64197) and final (75 FR 64123) regulations for hybrid plans implementing the changes made to hybrid plans under the PPA. The 2010 proposed regulations provided a list of permissible interest crediting rates that satisfy the market rate of return requirement to include:
Interest rates based on the actual rate of return on plan assets.
A fixed 5% rate.
A rate based on the greater of two interest crediting rates if:
the plan uses bond-based rates and includes a fixed interest rate floor of no more than 4% annually; and
the plan uses bond-based or equity-based rates and includes a cumulative interest rate floor of no more than 3%.
On September 18, 2014, the IRS issued additional final regulations to provide guidance on certain issues that were not addressed in the 2010 final regulations and make other changes to those sections. These rules are generally effective for plan years that begin on or after January 1, 2016 and provide guidance on:
An increase in the maximum permitted fixed interest credit to 6% from 5%.
An expanded list of interest crediting rates and combinations of interest crediting rates that satisfy the market rate of return requirement, including:
Basing interest credits on the return on a subset of plan assets, if certain requirements are met. (The 2010 proposed regulations permitted plans to credit interest based on the actual return on plan assets in the aggregate). Assuming the requirements are met, different groups of participants can have interest credits tied to different subsets of the plan’s assets.
The interest credits used to determine benefits after a plan termination.
Issues that arose from the 2010 proposed and final regulations on early retirement and optional-form of benefit subsidies.
The final regulations also permit defined benefit plans that adjust benefits using a variable rate that could be negative under the 133 1/3% rule to apply this rule earlier than permitted in the 2010 proposed regulations.
2014 Proposed Hybrid Plan Regulations
The proposed regulations provide transition relief from the anti-cutback rule for plans that use an interest crediting rate that is not permitted under the final regulations. A plan may be amended to change to an interest crediting rate that is permitted before the first day of the first plan year that begins on or after January 1, 2016. (Normally an amendment that reduces the interest crediting rate for benefits that have accrued would be an impermissible cutback that would violate IRC Section 411(d)(6) (seePractice Note, Protected Benefits under IRC Section 411(d)(6)).)
To obtain IRC Section 411(d)(6) relief under the proposed regulations, the amendment must be adopted before and effective no later than the first day of the first plan year that begins on or after January 1, 2016. The amended rate will apply to previously accrued benefits, but only for interest credits for periods after the amendment is adopted, or if later, for periods after the amendment is effective.
Comments on the proposed regulations are due by December 18, 2014. IRS representatives at a recent American Bar Association Section of Taxation meeting indicated that a hearing is scheduled on these proposed regulations in January of 2015 and they anticipate final regulations being issued in the early part of 2015.
Practical Implications
The proposed and final regulations provide some long anticipated guidance by addressing prior concerns from practitioners, including, raising the variable interest rate floor and permitting the crediting of interest rates equal to a subset of plan assets (if certain requirements are met). Plan sponsors may need to make meaningful changes to their plans but have some time for implementation since the IRS provided a January 1, 2016 effective date. Plans sponsors should review the implications of the guidance with their actuaries to determine whether action is needed.