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Guest Article

(From the October 25, 2010 issue of Deloitte's Washington Bulletin, a periodic update of legal and regulatory developments relating to Employee Benefits.)

Hybrid Plans: IRS Issues Final and Proposed Regulations

The IRS's newly-released final regulations regarding statutory hybrid plans incorporate the transitional guidance under Notice 2007-6 and the 2007 proposed regulations, with some noted clarifications. The proposed regulations, which were issued the same day, attempt to provide further guidance on several issues that are not addressed in the final regulations, including plan terminations and changes in the interest crediting rate when Code § 411(d)(6) protection applies, and would expand the list of permitted interest crediting rates. Notably, the proposed regulations can now be relied upon in complying with Code §§ 411(a)(13) and 411(b)(5).

Final Regulations

The final regulations, which are generally effective for plan years that begin on or after January 1, 2011, essentially maintain the status quo by keeping in place previously-issued guidance by the IRS in the 2007 proposed regulations and in Notice 2007-6. However, the IRS points out certain clarifications in the new final regulations, including:

Plans Subject - Pension Equity Plans, in which the formula provides for interest credits after the cessation of benefit accruals, would be subject to the market rate of return rules with regard to the interest credits.
Safe Harbor - Where a participant is provided with the "greater of" benefits that are expressed in two or more different forms, for the safe harbor to apply no similarly-situated younger participant can be provided with the sum of the same benefits. Nor, if the participant is provided with a choice of benefits expressed in two or more different forms, can the plan provide any similarly-situated younger participant with either the sum of, or the greater of, the same benefits if the safe harbor is to apply.
Recognized Index - The list of what constitutes a recognized index or methodology is expanded to include any rate of return that satisfies the market rate of return rules as a recognized index or methodology under the regulations.
No-Loss and Preservation of Capital Rules - Variable annuity benefit formulas, as defined in the regulation, are exempt from the no-loss and preservation of capital rules.
Conversion Protection - A conversion amendment must be both adopted and effective on or after June 29, 2005, in order for the conversion protection provisions to apply.
Interest Crediting - The exclusions from the definition of interest credit are expanded to also exclude adjustments made as a result of imputed service, and also certain one-time adjustments.
Market Rate of Return - An interest crediting rate is not in excess of a market rate of return if it can never be in excess of a particular rate that meets the market rate of return limitation (e.g., a rate that is a percentage no greater than 100 percent of a rate that meets the market rate of return limitation). Nor does a plan provide an effective interest crediting rate that is in excess of a market rate of return merely because the plan applies different rates to different portions of the accumulated benefits - as long as each rate would separately satisfy the market rate of return limitations if it was applied to the entire benefit.
Safe Harbor Rates - The list of safe-harbor rates is expanded to include all of the interest rates permissible under Code § 417(e) (e.g., the first and second segment rates regardless of whether calculated under the transition rule of Code § 417(e)(3)).
Preservation of Capital - The preservation of capital requirement applies to all principal credits that were credited under the plan as of the annuity starting date, including principle credits that were credited before the statutory effective date of the requirement.
Code § 411(d)(6) - The right to interest credits in the future that are not conditioned on future service constitutes a Code § 411(d)(6) protected benefit. An amendment to change the interest crediting rate must comply with Code § 411(d)(6) if the revised rate could result in interest credits that are smaller after the amendment.
Statutory Market Rate of Return - For plan years that begin before January 1, 2012, plans may utilize a rate that is permissible under the final regulations or the 2010 proposed regulations for purposes of satisfying the statutory market rate of return requirement.

Proposed Regulations

The proposed regulations provide guidance on certain issues that are not addressed in the final regulations. Comments are requested by January 12, 2011. The regulations are proposed to be effective for plan years beginning on or after January 1, 2012, but plans are permitted to rely on them now for purposes of satisfying Code § 411(a)(13) and Code § 411(b)(5).

The regulations address Code § 411(a)(13)(A), which provides that an applicable defined benefit plan does not fail to meet various specified qualification requirements simply because the present value of the accrued benefit is equal to the amount expressed as the balance of a hypothetical account or as an accumulated percentage of the participant's final average compensation. The regulations propose to:

Limit the relief of Code § 411(a)(13)(A),
Apply that section to distributions other than single sums,
Apply that section to plans with multiple formulas, and
Apply that section to pension equity plans (including those that do not credit interest).

Substantial proposals are also made with respect to Code § 411(b)(5) and its conversion protection requirements (i.e., an alternative method is proposed for certain plans that would not require a comparison at the annuity starting date of the benefit attributable to the opening hypothetical account with the benefit accrued prior to the conversion date), its interest crediting requirements (i.e., to broaden the list of permitted interest crediting rates), and in applying that section to plan terminations.

Under Code § 411(b)(1)(B), the regulations propose a special rule regarding application of the 133-1/3 percent rule to a statutory hybrid plan that adjusts benefits using a variable interest crediting rate that can potentially be negative in any given year. Special rules are also proposed regarding changes in interest crediting rates where Code § 411(d)(6) protection applies.

The information in this Washington Bulletin is general in nature only and not intended to provide advice or guidance for specific situations.

If you have any questions or need additional information about articles appearing in this or previous versions of Washington Bulletin, please contact:

Robert Davis 202.879.3094, Elizabeth Drigotas 202.879.4985, Mary Jones 202.378.5067, Stephen LaGarde 202.879-5608, Bart Massey 202.220.2104, Tom Pevarnik 202.879.5314, Sandra Rolitsky 202.220.2025, Deborah Walker 202.879.4955.

BenefitsLink is an independent national employee benefits information provider, not formally affiliated with the firms and companies who kindly provide much of the content and advertisements published on this Web site, including the article shown above.