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IRS Issues Final Regulations Providing Anti-Cutback Relief and Guidance for Hybrid Retirement Plans
Practical Law Legal Update w-000-7742 (Approx. 7 pages)
IRS Issues Final Regulations Providing Anti-Cutback Relief and Guidance for Hybrid Retirement Plans
by Practical Law Employee Benefits & Executive Compensation
| Published on 17 Nov 2015 • USA (National/Federal) |
The Internal Revenue Service (IRS) issued final regulations relating to hybrid retirement plans, including cash balance plans and pension equity plans (PEPs). The final regulations provide anti-cutback relief and guidance under the Internal Revenue Code so that hybrid plans may be amended to comply with the interest crediting rate requirements under previously issued hybrid plan regulations.
On November 13, 2015, the IRS issued final regulations providing anti-cutback relief under Internal Revenue Code (Code) Section 411(d)(6) so that hybrid retirement plans, including cash balance plans and pension equity plans (PEPs), may be amended to comply with the interest crediting rate requirements under previously issued hybrid plan regulations (80 Fed. Reg. 70680 (Nov. 16, 2015)).
Hybrid Plans: Background
Hybrid defined benefit plans, such as cash balance plans or PEPs, combine features of both defined contribution and defined 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.
The Pension Protection Act of 2006 (PPA) imposed an age discrimination safe harbor requiring that interest crediting rates cannot be greater than a market rate of return (see Practice Note, Cash Balance Plans: Post-PPA: Age Discrimination Safe Harbor).
In 2010 and 2014, the IRS issued two sets of final regulations on hybrid plans (the final hybrid plan regulations) that implemented the requirements of the PPA (for more information on those regulations, see Legal Update, IRS Issues Final Regulations Providing Guidance on Hybrid Retirement Plans and Proposed Regulations Providing Anti-Cutback Relief).
The final hybrid plan regulations provide a list of interest crediting rates and combinations of rates that do not exceed a market rate of return, as required by Code Section 411(b)(5)(B)(i). The provisions that provide for a list of rates are set forth at 26 CFR Sections 1.411(b)(5)-1(d)(1)(iii), (d)(1)(vi), and (d)(6)(i).
Final Regulations
The final interest rate crediting regulations:
- Finalize proposed regulations that were issued in September 2014 (for more information on the proposed regulations, see Legal Update, IRS Issues Final Regulations Providing Guidance on Hybrid Retirement Plans and Proposed Regulations Providing Anti-Cutback Relief).
- Amend the Treasury Regulations under Code Sections 411(a)(13) and 411(b)(5). They apply for purposes of Code Sections 411(b)(5)(B)(i) and 411(d)(6) (26 U.S.C. §§ 411(a)(13) and 411(b)(5)) and for purposes of ERISA Sections 204(b)(5)(B)(i) and 204(g) (29 U.S.C. §§ 1054(b)(5)(B)(i) and 1054(g)).
Anti-Cutback Rule
Ordinarily under the anti-cutback rule ofCode Section 411(d)(6) (26 U.S.C. § 411(d)(6)), a defined benefit plan may be amended to change the interest crediting rate with respect to benefits that have not yet accrued, but not for benefits that have already accrued. But before the first day of the first plan year that begins on or after January 1, 2017, a hybrid plan that uses an interest crediting rate that is not permitted under the final hybrid plan regulations must be amended to use a permitted interest crediting rate.
The final interest rate crediting regulations allow hybrid plans to be amended to change the interest crediting rate to a rate that is on the list of rates that satisfy the requirement of Code Section 411(b)(5)(B)(i). Under the final regulations, this type of amendment will not violate the anti-cutback rule of Code Section 411(d)(6). Specifically, the final regulations provide anti-cutback relief by permitting a plan with a noncompliant interest crediting rate to be amended:
- For benefits that have already accrued so that its interest crediting rate complies with the market rate of return rules.
- Only for interest credits credited for periods that begin on or after the later of the effective date of the amendment or the date the amendment is adopted.
For more information on the anti-cutback rule, see Practice Note, Protected Benefits under Code Section 411(d)(6).
The final regulations provide relief under Code Section 411(d)(6) so that hybrid plans may make transitional amendments to enable a plan to comply with the plan termination rules in the final hybrid plan regulations.
Special Rules
The IRS also added a special rule to the final interest crediting rate regulations to clarify that a hybrid plan amendment to correct a noncompliant feature that provides for a greater interest crediting rate than the specific amendment in the regulations does not violate Code Section 411(d)(6). For example:
- In any case in which it is permissible to address a noncompliant rate by capping the rate at the third segment rate, it will also be permissible to address the noncompliant rate by switching to the third segment rate.
- An amendment to switch to the third segment rate together with a permitted fixed minimum rate will be permissible.
The final interest crediting rate regulations provide a special rule for plans that provide for a cumulative floor (for example, in order to comply with Code Section 411(d)(6) in connection with a prior amendment to change the plan's interest crediting rate on accrued pay credits). When this special rule applies, the plan must be amended:
- To provide that the benefit for a participant is based solely on the benefit and the associated interest crediting rate that is greatest for that participant as of the applicable amendment date.
- Under other rules in the final regulations if the remaining interest crediting rate does not satisfy the market rate of return rules.
Extension
In response to comments requesting sufficient time to amend the plans to change the interest crediting rate to a permissible rate, the final regulations provide hybrid plans with more time to change the interest crediting rate than the proposed regulations did. The requirement that a plan not provide an effective rate of return in excess of a market rate of return is effective for plan years that begin on or after January 1, 2017.
The final regulations also delay the applicability date of certain provisions of the 2014 final hybrid plan regulations.
Separate Corrections
The final regulations permit amendments that change the specific feature that causes the plan's interest crediting rate to be noncompliant, while not changing other features of the existing rate. If the noncompliant interest crediting rate has more than one noncompliant feature, then each noncompliant feature must be addressed separately. The final regulations provide examples of how to make these changes.
Additional Flexibility for Plan Sponsors
The final interest crediting rate regulations provide hybrid plans with added flexibility in complying with the interest crediting rate requirements.
In response to comments on the 2014 proposed regulations requesting more flexibility, the final regulations in many cases permit a hybrid plan sponsor to choose one of two or more alternative amendments in order to bring a plan into compliance.
The preamble to the final regulations explains that a hybrid plan may have been amended to change its interest crediting rate under the rules of Section 1107 of the PPA. If an interest crediting rate adopted under the rules of Section 1107 is not permitted under the final hybrid plan regulations, then the final interest crediting rate regulations permit a subsequent amendment to change the plan's rate to a rate permitted under the final hybrid plan regulations.
The final regulations also provide a rounding rule that allows hybrid plans to round an annual rate to the nearest multiple of 25 basis points or a smaller rounding interval.
Bond-Based Rates
The final interest crediting rate regulations add an additional option in each case involving bond-based rates so that any noncompliant variable rate that is not an investment-based rate, including the greater of two or more non-investment based variable rates, may be capped at the third segment rate.
Investment-Based Rates
The final interest crediting rate regulations also provide flexibility for noncompliant investment-based rates in the following ways:
- If a plan credits interest using a noncompliant investment-based rate but no permitted investment-based rate has a similar risk and return as the plan's impermissible rate, the final regulations permit an amendment to switch to the third segment rate with a 4% fixed minimum rate.
- Under the specified corrective amendment from the proposed regulations, it is permissible to switch to a permitted investment-based rate that is otherwise similar to the plan's impermissible investment-based rate but without the impermissible risk and return characteristics of the latter.
- To address the noncompliance that results from the availability of at least one hypothetical investment option that provides for an impermissible rate of return, the rules of the final regulations may be applied separately to correct each impermissible hypothetical investment option.
Composite Rate
The final regulations also provide greater flexibility for bringing a plan into compliance if the plan credits interest using a composite rate that is an investment-based rate of return with an impermissible annual (or more frequent) fixed or variable rate. Plans may either:
- Eliminate the fixed minimum rate (or any variable non-investment based rate) and eliminate any reduction to the investment-based rate.
- Switch to the third segment rate.
Applicability Date
The final regulations:
- Apply to plan amendments made on or after September 18, 2014 (or an earlier date as elected by the taxpayer).
- Do not apply to plan amendments made on or after the first day of the first plan year that begins on or after January 1, 2017.
- Apply to plan amendments to collectively bargained plans made before the first day of the first plan year that begins on or after January 1, 2019. However, if the last collective bargaining agreement (CBA) ratified on or before November 13, 2015 expires before January 1, 2019, the final regulations do not apply to amendments made on or after the first day of the first plan year that begins on or after the later of:
- the date on which the last applicable CBA expires; or
- January 1, 2017.
Practical Impact
The final interest crediting rate regulations and the final hybrid retirement plan regulations work in tandem. Sponsors of hybrid plans should be aware that the interest crediting rate regulations allow them to amend their plans to ensure that they do not provide an effective rate of return in excess of a market rate of return. By avoiding rates in excess of the market rate of return, plans can reduce their costs and have better financial health.