Proposed IRS Rules Expand Options for Cash Balance Plans

Regulations seek to reduce employer investment risk, minimize funding issues

By Stephen Miller November 2, 2010

updated 9/22/2014

Update: IRS Adopts Cash Balance Rules In 2014

The U.S. Internal Revenue Service delayed the effective date of cash balance pension plan rules it proposed in 2010 (see story, below). The proposed rules involved a provision in the Pension Protection Act that allowed plan sponsors to use a “market rate” to credit interest to participants’ account balances. When the rules were unveiled, the IRS said they would take effect on Jan. 1, 2012. But in October, 2011, the IRS said that finalized rules would be effective no earlier than Jan. 1, 2013.

Off by more than a year, new final regulations were ultimately adopted in September 2014; see the SHRM Online article Final Cash Balance Rule Expands Rate Options.

On Oct. 19, 2010, the U.S. Internal Revenue Service (IRS) published in the Federal Register Additional Rules Regarding Hybrid Retirement Plans.

The proposed regulations are intended to enhance cash balance (hybrid) defined benefit retirement plans by minimizing funding issues that have prevented some employers from offering these plans, according to an analysis by Kravitz, a retirement plan consultancy.

(To learn more about cash balance plans and how they work, see the SHRM Online article "Cash Balance Retirement Plans: They're Back!")

Interest Crediting Rate

Prior to the proposed regulations, the IRS had not finalized the definition of “market rate of return” for setting a cash balance plan’s "interest crediting rate" (ICR). In cash balance plans, participant accounts grow through a combination of employer contributions and annual interest credits determined by the ICR. Employers have relied on several safe harbor rates, such as the 30-year Treasury rate.

Among the proposed changes regarding the ICR are:

1. Actual rate of return on plan assets.This option would be allowed as long as the employer chooses diversified investments to minimize the volatility of returns. The challenges of exceeding or falling short of a targeted ICR every year are largely eliminated under this option, according to the analysis by Kravitz.

2. Equity-based rates.Employers would be able to choose an ICR equal to the rate of return offered by a registered investment company such as a mutual fund, as long as it is reasonably expected to not be significantly more volatile than the overall U.S. equity market or a similarly broad international equities market.

3. Fixed rates and combining rates.An ICR would be permitted to equal a stand-alone fixed rate of up to 5 percent or an annual floor of 4 percent in conjunction with any of the safe harbor rates.

In addition, a "preservation of capital" rule in the proposed regulations is intended to protect plan participants so that they could not receive less than the aggregate of all employer contributions at the time of withdrawal.

According to Kravitz, the rules are designed to encourage employers to add cash balance plans as a way to strengthen the overall U.S. retirement system. This is particularly important as traditional defined benefit plans continue to decline.

“Employers are looking for ways to maximize retirement contributions beyond a 401(k) plan. Cash balance plans are an effective way for business owners to increase personal and employee retirement contributions, retain employees, and receive tax deductions,” commented Dan Kravitz, president of Kravitz Inc.

Comments on the proposed regulations, due by Jan. 12, 2011, may be submitted via the Federal eRulemaking Portal at REG–132554–08). The IRS has scheduled a public hearing on the regulations at its offices in Washington, D.C., on Jan. 26, 2011.

Stephen Milleris an online editor/manager for SHRM.​

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