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A One-Sentence Hidden Gem Springs to Life in Secure 2.0


One sentence in the massive budget bill just signed by President Biden has the potential to have a profound impact on retirement programs sponsored by U.S. employers. No, this one sentence is not directly related to the many other good changes affecting defined contribution plans. Rather, it opens the door for a modern variation of a kind of defined benefit plan that has existed and thrived since the 1980s – the cash balance plan.

This one sentence is found in Section 348 in Title III, Simplification and Clarification of Retirement Plan Rules. Section 348 is simply entitled CASH BALANCE. The sentence is added to the end of Section 411(b) of the Internal Revenue Code (and corresponding provision of ERISA) and serves to clarify how the so-called anti-backloading rules apply to a cash balance plan that provides interest credits using a variable basis (i.e., anything other than a fixed rate such as 5%). The language states that in running one of the anti-backloading tests, a reasonable rate, not to exceed 6%, should be used.

Why is this a big deal? Because the Treasury Department and IRS have been applying a different rule until now. That rule required that the tests be performed assuming the current (or most recent) rate should be assumed to continue in future years in projecting an employee’s benefit at normal retirement age. That interpretation of the law has led to illogical and unworkable outcomes in many situations, causing many employers who otherwise might adopt or maintain a cash balance plan not to do so.

The replacement of the regulators’ interpretation with this one sentence eliminates a plan design impediment thereby opening the door to cash balance designs that provide more employer cost stability and predictability and better employee outcomes.

In particular, cash balance plans that credit interest using actual rates of return on specified investments — explicitly permitted by the Pension Protection Act of 2006 — have become a much more viable option for sponsors of the many existing cash balance plans that did not make such a change because doing so would have required them to sharply reduce the incentives for longer service or older employees baked into their cash balance benefit credits. 

Many of those same sponsors were forced to include fixed minimum interest crediting rates (e.g., 4%) in addition to their variable bond-based interest credits (e.g., 30-year Treasury rates to satisfy the regulators’ interpretation of the anti-backloading rules. Those minimum crediting rates, in turn, were a major element in causing financial volatility of contribution and accounting outcomes. The one-sentence law change would allow sponsors of those plans to eliminate the minimum interest crediting rate, whether or not the sponsor decides to change the basis to credit interest to market-return rates.

Employers that sponsor cash balance plans with ongoing or even frozen benefit credits should examine how this one-sentence could present a new and better path to providing secure lifetime retirement income in a way that will help their employee recruitment and retention in a way that is more cost efficient and financially viable for their companies.”  
Larry Sher is a partner at October Three Consulting. 

Used by permission. Opinions expressed are those of the author, and do not necessarily reflect the views of ASPPA or its members.

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