The IRS released two new regulation packages today dealing with "cash balance" and other "hybrid" pension plans.They provide some important clarifications on implementation of the "market rate" requirement enacted in 2006 as part of the Pension Protection Act. The market-rate requirement ensures that cash-balance plans do not discriminate against older workers by crediting interest at an unreasonably high rate.

Final Regulations. One package of rules finalizes (at long last) market-rate-of-return regulations under Code Section 411(b)(5) that were proposed in 2010. Among other things, the regulations identify the types of interest-crediting rates that will be considered market rates of return, including:

  • the 430(h)(2)(C) segment rates (adjusted or unadjusted),
  • the actual rate of return on plan assets (if conditions are satisfied),
  • the rate of return on certain regulated investment companies (RICs), and
  • a fixed rate of up to 6% (increased from 5% in the proposed regulations).

Interest Rate Floors. The final regulations address the use of an annual or cumulative floor on a variable interest-crediting rate and allow for a floor of up to 5% annually (increased from 4% in the proposed regulations) in connection with any Notice 96-8 rate (e.g., the yield on 30-year Treasury Constant Maturities) and a floor of up to 4% annually in connection with any of the 430(h)(2)(C) segment rates. An investment-based interest-crediting rate (including the rate of return on plan assets) cannot be subject to an annual floor, but may be subject to a cumulative floor of up to 3%.

Other Section 411 Issues. The final regulations also address a handful of other issues related to hybrid plans under Code Section 411, including lump-sum formulas, anti-backloading, conversion amendments, interest rates in plan terminations, and compliance with 411(d)(6) when amending a plan to change interest-crediting rates.

Self-Direction of Investments. The preamble notes that Treasury and IRS are continuing to study whether self-direction of investments in hybrid plans is permissible but are declining to provide guidance at this time. However, to the extent hybrid plans elect to provide for self-direction of investments in the absence of specific guidance, plan provisions adopted after the publication of these regulations will not be eligible for anti-cutback relief in the event of future guidance expressly prohibiting self-direction.

Applicability of Final Regulations. The final regulations apply for plan years beginning on or after January 1, 2016, except to the extent they merely clarify guidance provided in the 2010 final regulations, in which case they apply to plan years beginning on or after January 1, 2011. In addition, the market-rate provisions of the 2010 final regulations (1.411(b)(5)-1(d)(1)(iii), (d)(1)(vi), and (d)(6)(i)) that were delayed by Notice 2011-85 and Notice 2012-61 are expressly amended to apply for plan years beginning on or after January 1, 2016.

Proposed Regulations. A second package of regulations (in proposed form) provides a mechanism for hybrid plans to amend their interest-crediting rates without violating 411(d)(6), if necessary to satisfy the market-rate-of-return regulations. Consistent with the guidance previously provided in Notice 2011-85 and Notice 2012-61, a plan that uses an interest-crediting rate that is not permitted under the final market-rate regulations can be amended without violating 411(d)(6) if the amendment is adopted before, and is effective no later than the beginning of, the first day of the plan year that begins on or after January 1, 2016. The change in interest-crediting rates is permitted with respect to benefits that have already accrued, but the interest credits themselves may not be retroactively reduced. Only interest credits made on or after the date the amendment is adopted (or, if later, the date it is effective) can be made at the new rate.

Manner of Modifying Interest-Crediting Rates. The proposed regulations provide very precise rules governing the manner in which interest-crediting rates may be modified. The permitted changes or correction methods differ depending on the nature of the problem being corrected.

Applicability of Proposed Regulations. The regulations are proposed to be effective upon finalization, but Section 7805(b) relief is proposed to apply to any plan amendments adopted before the date the regulations are finalized. In other words, they can essentially be relied on immediately.

The final regulations are available here.

The proposed regulations are available here.