The IRS has released final regulations that provide guidance and, notably, another year to comply with, what are now final hybrid plan rules.
The action comes as time was running out for IRS to publish — and plans to implement — transitional anti-cutback relief for plan amendments reducing above-market interest-crediting rates.
The final regulations apply to defined benefit plans that use a lump sum-based benefit formula, including cash balance plans and pension equity plans, as well as other plans that have formulas with an effect similar to a lump sum-based benefit formula.
Updates to 2014 Proposed Regulations
These final regulations relate to previously issued final regulations that specify permitted interest crediting rates for purposes of the requirement that an applicable DB plan not provide for interest credits (or equivalent amounts) at an effective rate that is greater than a market rate of return. According to the IRS, they permit a plan sponsor of an applicable DB plan that does not comply with the market rate of return requirement to amend the plan in order to change to an interest crediting rate that is permitted under the previously issued final hybrid plan regulations without violating the anti-cutback rules of Internal Revenue Code Section 411(d)(6).
In order to resolve the conflict between the market rate of return rules of section 411(b)(5)(B)(i) and the anti-cutback rules of Section 411(d)(6), these regulations permit a plan with a noncompliant interest crediting rate to be amended with respect to benefits that have already accrued so that its interest crediting rate complies with the market rate of return rules. If the applicable requirements of these regulations are satisfied, that type of amendment is permitted with respect to benefits that have already accrued, but only with respect to interest credits that are credited for interest crediting periods that begin on or after the later of the effective date of the amendment or the date the amendment is adopted.
As with the 2014 proposed regulations, these final regulations 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. If the noncompliant interest crediting rate has more than one noncompliant feature, then each noncompliant feature must be addressed separately in the prescribed manner. Examples are included in the regulation to illustrate how these rules would be applied.
The IRS notes that these final regulations also provide flexibility with respect to noncompliant investment-based rates. In particular, the IRS explains that if a plan credits interest using a noncompliant investment-based rate and there is no permitted investment-based rate with similar risk and return characteristics as the plan’s impermissible rate, then, as an alternative to the specified corrective amendment that was in the proposed regulations, an amendment to switch to the third segment rate with a 4 percent fixed minimum rate is permitted. The regulations also clarify the specified corrective amendment that was in the proposed regulations — by providing that it is permissible in such a case to switch to a permitted investment-based rate that is otherwise similar to the plan’s impermissible investment based rate but without the risk and return characteristics of the impermissible rate that caused it to be impermissible.
Hypothetical Investment Option Plan Concerns
The IRS also notes that the preamble to the 2014 final hybrid plan regulations contained a discussion of statutory hybrid plans that permit participants to choose from among a menu of hypothetical investment options, and that because of what it described as “significant concerns” relating to the use of these plan designs, not only will the Treasury Department and the IRS continue to study the issues raised in the preamble to the 2014 final hybrid plan regulations related to these plans, but that it is possible that the Treasury Department and the IRS will conclude that such plan designs are not permitted. They do note, however, that Treasury and the IRS “…understand that some of these plans contain one or more hypothetical investment options that provide for a rate of return that is not permitted under the final hybrid plan regulations”, and explain that a special rule is included in these regulations in order to address the noncompliance that results from the availability of at least one hypothetical investment option that provides for an impermissible rate of return.
These regulations generally apply to plan amendments made on or after Sept. 18, 2014 (or an earlier date as elected by the taxpayer), and they do not apply for amendments made on or after the first day of the first plan year that begins on or after Jan. 1, 2017.
The final regulations — 31 pages worth — can be found online here.
Stay tuned for an ASPPA asap with analysis and insights!
The action comes as time was running out for IRS to publish — and plans to implement — transitional anti-cutback relief for plan amendments reducing above-market interest-crediting rates.
The final regulations apply to defined benefit plans that use a lump sum-based benefit formula, including cash balance plans and pension equity plans, as well as other plans that have formulas with an effect similar to a lump sum-based benefit formula.
Now plans that credit interest at an above-market rate have until the 2017 plan year to bring their plans into compliance, and plans that might have fallen out of the age discrimination safe harbors in 2016 — plans that continue to perform a lump sum whipsaw calculation, or provide an annuity not reasonably equivalent to the account balance — now have an additional year to address the issues created by the final rule. Additionally, plan amendments necessary to comply with the final regulations (such as preservation of capital and the special plan termination requirements) are also not required before the end of the 2016 plan year.
Updates to 2014 Proposed Regulations
These final regulations relate to previously issued final regulations that specify permitted interest crediting rates for purposes of the requirement that an applicable DB plan not provide for interest credits (or equivalent amounts) at an effective rate that is greater than a market rate of return. According to the IRS, they permit a plan sponsor of an applicable DB plan that does not comply with the market rate of return requirement to amend the plan in order to change to an interest crediting rate that is permitted under the previously issued final hybrid plan regulations without violating the anti-cutback rules of Internal Revenue Code Section 411(d)(6).
In order to resolve the conflict between the market rate of return rules of section 411(b)(5)(B)(i) and the anti-cutback rules of Section 411(d)(6), these regulations permit a plan with a noncompliant interest crediting rate to be amended with respect to benefits that have already accrued so that its interest crediting rate complies with the market rate of return rules. If the applicable requirements of these regulations are satisfied, that type of amendment is permitted with respect to benefits that have already accrued, but only with respect to interest credits that are credited for interest crediting periods that begin on or after the later of the effective date of the amendment or the date the amendment is adopted.
As with the 2014 proposed regulations, these final regulations 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. If the noncompliant interest crediting rate has more than one noncompliant feature, then each noncompliant feature must be addressed separately in the prescribed manner. Examples are included in the regulation to illustrate how these rules would be applied.
The IRS notes that these final regulations also provide flexibility with respect to noncompliant investment-based rates. In particular, the IRS explains that if a plan credits interest using a noncompliant investment-based rate and there is no permitted investment-based rate with similar risk and return characteristics as the plan’s impermissible rate, then, as an alternative to the specified corrective amendment that was in the proposed regulations, an amendment to switch to the third segment rate with a 4 percent fixed minimum rate is permitted. The regulations also clarify the specified corrective amendment that was in the proposed regulations — by providing that it is permissible in such a case to switch to a permitted investment-based rate that is otherwise similar to the plan’s impermissible investment based rate but without the risk and return characteristics of the impermissible rate that caused it to be impermissible.
Hypothetical Investment Option Plan Concerns
The IRS also notes that the preamble to the 2014 final hybrid plan regulations contained a discussion of statutory hybrid plans that permit participants to choose from among a menu of hypothetical investment options, and that because of what it described as “significant concerns” relating to the use of these plan designs, not only will the Treasury Department and the IRS continue to study the issues raised in the preamble to the 2014 final hybrid plan regulations related to these plans, but that it is possible that the Treasury Department and the IRS will conclude that such plan designs are not permitted. They do note, however, that Treasury and the IRS “…understand that some of these plans contain one or more hypothetical investment options that provide for a rate of return that is not permitted under the final hybrid plan regulations”, and explain that a special rule is included in these regulations in order to address the noncompliance that results from the availability of at least one hypothetical investment option that provides for an impermissible rate of return.
These regulations generally apply to plan amendments made on or after Sept. 18, 2014 (or an earlier date as elected by the taxpayer), and they do not apply for amendments made on or after the first day of the first plan year that begins on or after Jan. 1, 2017.
The final regulations — 31 pages worth — can be found online here.
Stay tuned for an ASPPA asap with analysis and insights!
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