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New Hybrid Regulations Address Cash Balance Plan Requirements

Last week, the Internal Revenue Service (IRS) released long-awaited regulations regarding hybrid plans. The regulations are split into two portions final regulations that update regulations that were originally proposed back in 2010 and newly proposed regulations. The final regulations primarily address the market-rate-of-return requirement for cash balance plans (i.e., what constitutes a permissible interest crediting rate) and issues related to whipsaw relief. The proposed regulations address the transition from a noncompliant interest crediting rate to one that is permitted under the final regulations.

Overall, we are pleased with the final and proposed regulations, although we didn't get everything we asked for. We are continuing to study the regulations and their application to sponsors' plans. To the extent that you identify issues of concern, please let us know.

We will be scheduling a conference call very soon on the final and proposed regulations. The call will summarize the regulations and will identify compliance strategies for different types of plans. We will also discuss possible comments on the proposed regulations. The Coalition will be submitting comments on the proposed regulations (which are due by December 18th) and requesting the opportunity to testify at the hearing on those regulations on January 9th.

Following are the highlights of the regulations:

Effective date/sufficient time to implement changes: A key issue for the Coalition has been ensuring that all plan sponsors have at least 12 months to assess the regulations and implement any necessary changes. The final regulations are generally effective for plan years beginning on or after January 1, 2016, which provides the time we requested (assuming the proposed transition guidance is finalized in a timely fashion).

Minimizing plan disruption/market rate of return: Another key objective of the Coalition has been minimizing disruption of existing plans. In this regard, we were able to use our extensive database of plan features to identify needed changes to the proposed market rate of return regulations. We identified three main issues:

  • Minimum rate of return. Under the originally proposed regulations, a plan that credited interest at the greater of a bond-based rate of return or a minimum rate of return could not set that minimum above 4%. We asked that the highest minimum permitted be increased to at least 5%. The final regulations provided an increase to 5% except in the case of crediting rates based on the segment rates used for funding purposes.
  • Fixed rate of return. Under the originally proposed regulations, the highest permitted fixed rate of return was 5%. We asked that that be raised to at least 6%, and the final regulations increased it to 6%.
  • Use of market rates not listed: Under the originally proposed regulations, only specific rates of return identified in the regulations could qualify as market rates of return, so that other rates of return available in the market, such as investments available under the plan sponsor's 401(k) plan, would not qualify. We generally asked that all rates available in the market qualify as market rates. The final regulations retained the limited structure of the originally proposed regulations.

Minimizing plan disruption/permitting subsidies: The originally proposed regulations would have generally precluded hybrid plans from providing early retirement and optional-form subsidies as a condition of qualifying from relief from whipsaw. This would have disrupted a number of plans, and was another focus of Coalition concerns. The final regulations generally resolved these issues favorably.

Clear administrable path to come into compliance.

  • Opportunity to comment on transition rules. The Coalition emphasized the importance of the opportunity to comment on the transition rules permitting plans with above market rates of return to modify such rates without violating the anti-cutback rules. As noted, the IRS issued proposed transition rules, subject to public comment.
  • Clear flexible rules. The Coalition stressed the importance of clear, flexible transition rules. More specifically, we asked that the rules permit a change from a noncompliant interest crediting rate to any of the maximum-compliant interest crediting rates.
    • The proposed rules do not provide the flexibility requested. Instead, the general approach in the proposed regulations is to permit amendments that bring the plan into compliance by changing the specific feature that causes the plan's interest crediting rate to be noncompliant, while not changing other features of the existing rate. The proposed regulations are fairly prescriptive for simple rates but are more complex for the combination rates that are common to many hybrid plans.
    • Although the proposed regulations are restrictive, they are very responsive to the core point that plan sponsors need a clear means to come into compliance.
    • It is our hope that the IRS will be open to further changes to ease the transition for both employers and employees, especially with respect to flexibility.
  • Timing. To qualify for the anti-cutback relief, the proposal requires plan amendments to be adopted prior to and effective no later than the first day of the first plan year that begins on or after January 1, 2016. The IRS also proposes to allow plan sponsors to apply the regulations, as finalized, to plan amendments that are adopted during earlier periods.

Pre-effective date compliance: The Coalition has also stressed the need of plan sponsors for protection from liability for the “transition period,” i.e., the period between the statutory effective date of the market rate of return rules (generally the first day of the 2008 plan year) and the regulatory effective date (the first day of the 2016 plan year). For example, in the case of a plan with a fixed rate of return of 6.5%, it would have been very difficult to reduce that rate prior to final guidance on market rates and on anti-cutback relief. So now, the plan sponsor could face uncertainty if there is an inference that the regulatory rule – prohibiting fixed rates above 6% -- is the best interpretation of the statute and thus has been the law since the statutory effective date. The Coalition asked that rates of return that were reasonable when they were established be treated as permissible during the transition period. Instead, the preamble to the final regulations states that no inference should be drawn from the final regulations regarding the law in effect during the transition period.

Pension Equity Plans (PEPs): Neither the final nor proposed regulations contain substantial guidance on PEPs, though the final regulations do helpfully clarify that a reduction in the accumulated benefit under a PEP formula is permitted to the extent that it results from a decrease in the participant's final average compensation or from an increase in the integration level (in the case of a formula that is integrated with Social Security). The IRS has a separate project regarding these plans on its guidance schedule.

The Coalition has been and will continue to be very active with respect to the PEP issues, including attempting to (1) minimize disruption of existing plans, (2) prevent new PEP rules from having retroactive effect, and (3) prevent application of new IRS enforcement positions in the context of examinations or determination letter requests before the guidance process has taken place. Unfortunately, such application of new IRS enforcement positions has already begun, which adds more urgency to the Coalition’s efforts in this regard.

For more information or if you any questions, please contact Kent Mason (kamason@davis-harman.com; 202-662-2288) at Davis & Harman or visit the Coalition’s website at www.preservedb.com.