Firm Raises Concern With Proposed Hybrid Pension Plan Regs

Some companies that maintained cash balance pension plans prior to the enactment of the market-rate rules under the Pension Protection Act of 2006 had amended the provision defining the applicable interest crediting rate under the plan at various times before 2006. In our view, the transitional amendment guidance provided under the proposed regulations does not adequately address issues raised for such plans, and potentially makes the amendments necessary to bring such plans into compliance unduly complicated.

As an example, one of our clients has maintained a cash balance plan since 1990, and has amended the plan twice to change the interest crediting rate. From inception through the end of the 2000 plan year, the interest credit for a plan year was equal to the average 30-year Treasury Constant Maturity rate for the 36 months ending September 30 of the preceding year, rounded to the nearest 25 basis points. Effective January 1, 2001, the interest crediting rate was changed to the average 10-year Treasury Constant Maturity rate for the 12 months ending December 31 of the preceding year, rounded to the nearest 25 basis points. The rate was changed again effective January 1, 2004, to the average 5-year Treasury Constant Maturity rate for the 12 months ending December 31 of the preceding year plus 25 basis points and rounded to the nearest 25 basis points. The plan was frozen so that no principal credits accrued after April 1, 2006. (As it happens, each of these interest crediting rate rules individually would satisfy the safe harbor interest rate rules under Treas. Reg. § 1.411(b)(5)-1(d)(4)(ii), but for the lookback month averaging period, and possibly the rounding adjustment.)

Each time the plan was amended, the new rate was extended to all plan participants with account balances, including those who terminated before the amendment date. And, as required by Code Section 411(d)(6), the plan preserved a legal minimum benefit in connection with each amendment. For an individual who participated in the plan before 2001, the cash balance account -- reflecting interest credits at the 30-year Treasury rate through 2000, the 10-year Treasury for 2001 through 2003, and the 5-year Treasury rate plus 0.25% after 2003 -- is subject to two minimums:

• The account balance at December 31, 2000, accumulated with interest at the original 30-year Treasury rate.

• The account balance at December 31, 2000, plus any principal credits earned for the 2001-2003 plan years, accumulated with interest at the 10-year Treasury rate.

Under Treas. Reg. § 1.411(b)(5)-1(d), these plan provisions raise three sets of issues that may need to be addressed to bring the plan into compliance:

Clarification of Rounding of Interest Crediting Rates

To simplify administration, the plan currently rounds applicable interest rates to the nearest 25 basis points. The market-rate rules do not address rounding, and we do not believe that application of rounding up in determining an interest rate for a particular year, when rounding down might occur in other years, should result in the plan's interest rate to be considered to provide an impermissible margin with regard to an otherwise permissible market rate of interest, requiring correction under the transition rules. There is no reason to expect that the consistent application of a "rounding nearest" rule would increase the interest credits above the application of the unrounded market rate, when considered on a cumulative basis. Thus, we urge the Treasury Department and IRS to adopt a rule clarifying that a plan that rounds an otherwise permissible market rate to the nearest specified number of basis points is considered to be applying that permissible market rate, and that any rounding up pursuant to the rounding rule will not be considered to be a "margin" for purposes of Treas. Reg. § 1.411(b)(5)-1(d)(4)(ii).

Application of the Transition Rules

Under the transition rules, multiple noncompliant featured must each be separately addressed. (Prop. Treas. Reg. § 1.411(b)(5)-1(e)(3)(vi)(B)(1).) In the example of our client's situation, this means fixing the three interest rates to use an appropriate lookback period. (Prop. Treas. Reg. § 1.411(b)(5)-1(e)(3)(vi)(C)(1).)

The transition rules then would require that the impermissible "greater of" interest crediting be fixed for participants who were not active participants on the date 6f an interest rate change. The transition rules would require that, effective January 1, 2016, these participants' accounts would be credited with interest at a rate equal to the lesser of (i) the greatest of the corrected interest rates that are applicable to that participant's account and (ii) the third segment rate. (Prop. Treas. Reg. § 1.411(b)(5)-1(e)(vi)(C)(5).) For each participant, a determination would need to be made as to whether the participant was active al the time of each rate change, in order to determine which rates would be compared and whether the third segment rate would apply. Current plan rules using the various interest rates as corrected under the transition rules would continue to apply to participants who were active at the time of both rate changes. As noted above, it is unclear exactly how the third-segment-rate cap is applied to a cumulative "greatest of" calculation performed only at the annuity starting date,

Transition Rule Simplification

As described above, the application of the transition rules to this client and those in similar situations would present a heavy ongoing administrative burden. The client was put in this situation due to its good faith effort to protect the accrued benefits of plan participants in conjunction with changes in the interest rates and to apply a uniform interest rate to all participants' accounts. The market-rate rules were not in effect at the time such companies effected these interest crediting rate changes, and the resulting "greater of" formula, as characterized in the market-rate rules, was solely the result of an attempt to both protect the accrued benefits of plan participants and apply a uniform interest crediting rate going forward. The transition rules would require imposing the third segment rate cap on a sub-group of participants, while current plan rules continue to apply to other participants, creating an inconsistency among participants that many plans would generally try to avoid.

Even if steps were taken to implement the required administrative changes under the proposed transition rules and put into place the complex processes for properly calculating benefits, it is very unlikely that any participant's benefit would be impacted. The third segment rate is very unlikely to ever be lower than the greatest of the Treasury rates currently used by the plan to credit interest.

Because of the administrative complexities of applying the proposed transition rules, the resulting inconsistency in treatment of participants, and the unlikely impact on any participant's benefits, we urge the Treasury Department and IRS to consider including a provision in the final transition rules that provides relief for a plan that is considered to have an impermissible "greater of" formula for determining interest rates as a result of a plan amendment or amendments adopted prior to September 19, 2014 that changed the plan's interest crediting rate for all participants going forward, but preserved accrued benefits for all participants by providing that a participant's benefit would never be less than the account balance as of the date of the rate change, adjusted for the interest credits at the rate applicable before the change. The final transition rules should provide that such plans will be considered to comply with the market-rate rules, with relief from the anti-cutback rules, if it applies either of the following approaches: