IRC401 Posted November 26, 1999 Share Posted November 26, 1999 I am beginning to see cash balance plans which permit employees to rollover DC plan account balances to the cash balance plan. The rolled over amount is converted into a cash balance and credited with "interest" as if it were a benefit accrual. Companies apparently want this feature in their plans because they expect the plan to earn a greater return than the "interest" that is being credited; so, the plan makes a profit off of the transaction, which could boost corporate earnings. I can't figure out why an employee would go for this unless he is terrified of investing, and the plan is offering a higher rate of return than a money market fund. I wonder whether any one has considered whether this sort of plan provision creates a prohibited transaction. What is happening as a matter of economic reality is that the pension plan is selling annuities to participants in the DC plan. If the DB were to sell annutities directly, wouldn't it need to become a state regulated insurance company? Therefore, I wonder if this sort of provision subjects the plan trustees to regulation by the state insurance commissioner. I assume that the conventional wisdom is that the DC account is being converted into a DB accrued benefit. If that is the case, does anyone have any authority that such a presto-chango conversion is permissible? If it is permissible, then it seems to me that IRC 414(i) and 414(j) have no meaning, and why isn't the reverse permissible? Other questions: - Are the rollover amounts subject to the PBGC insurance program? There doesn't appear to be any policy reason why the PBGC should start to insure DC accounts. - May a plan give a higher rate of interest to HCEs than non-HCEs? Why not? The rollover amounts are not subject to IRC 401(a)(4). It seems to me that the only limit should be the point at which the IRS asserts that the interest rate is so high that the HCE is in fact accruing a benefit. Therefore, if this sort of DB to DC conversion is permissible, there are all sorts of planning opportunities. - May a 401(k) plan make a pre-59 1/2 inservice (non-hardship) transfer to a DB plan (getting around IRC 401(k)(2)(B))? [NOTE: I understand that Bank of America did put such a provision in its 401(k) plan. Does anyone have any inside information on the Bank of America plan?] - Is there a point at which the rollover assets are so large that the DB plan is no longer a DB plan? Does anyone know of any authority to permit DC rollovers to DB plans (without keeping the rollovers as separate DC accounts)? Am I missing something? Thank you. Link to comment Share on other sites More sharing options...
richard Posted November 27, 1999 Share Posted November 27, 1999 Very interesting issues you raise. Some observations. I don't know of any authority that would permit (or prohibit) transferring DC accounting into DB plans and crediting them "benefit accrual -- cash balance type" interest. However, assuming one can do so, I believe that these assets and liabilities becomes part of the DB plan, since the investment risk is transferred to the plan and away from the participant. (Note the contrast with 414k accounts.) That being said, these assets and liabilities would be subject to PBGC insurance premiums. Also, these assets and liabilities would not be DC accounts, so the PBGC shouldn't have any problem insuring them. (In fact, they would welcome it, since, at least initially, the liabilities would essentially be fully funded.) Would the rollover assets be so large that the DB plan would no longer be a DB plan? Since, according to my logic, these become part of the DB liabilities, your question becomes moot. I have seen 414k assets and liabilities (which are DC accounts in DB plans) being as large as 75% of the total plan (DB+DC) assets without problems, however. As far as crediting higher interest accruals for HCEs vs nonHCEs, this is no different than in a regular cash balance plan. It can be done but can cause major problems. Although the actual rollover would not be subject to 401(a)(4) [except for the effective availability requirements, so you couldn't offer the ability to rollover only to HCEs], the interest accruals are subject to 401(a)(4) just as any other benefit accrual, and would have to be tested accordingly. Different interest crediting rates could cause other problems involving 417(e) and 411(a) backloading as well. If it sounds complicated, it is. And from a public policy perspective, I believe these rollovers do make quite a bit of sense. (All of this represents my very humble opinion, and should be considered as such.) Link to comment Share on other sites More sharing options...
david rigby Posted November 29, 1999 Share Posted November 29, 1999 Interesting comments. Could you elaborate on your "public policy" comment? I'm a retirement actuary. Nothing about my comments is intended or should be construed as investment, tax, legal or accounting advice. Occasionally, but not all the time, it might be reasonable to interpret my comments as actuarial or consulting advice. Link to comment Share on other sites More sharing options...
Alonzo Posted November 29, 1999 Share Posted November 29, 1999 I could see this transaction working if there is a true "distributable event" in the defined contribution plan. Say, the participant terminated employment, and moved his money into the db plan because he wanted to increase his annuity in the db plan. I remember this being touted as an innovative db/dc plan design 6 or 7 years ago. An in-service transfer to the db plan from the dc plan cannot be converted into a db accrued benefit unless there has been a distributable event in the dc plan. See 1.411(d)-4, Q&A 3. So, a pre 59-1/2 transfer to a cash balance plan from a plan account containing deferrals should not be allowed. Such rules as there are in this area are contained in 1.411(d)-4, Q&A 3. Link to comment Share on other sites More sharing options...
IRC401 Posted December 2, 1999 Author Share Posted December 2, 1999 It appears that elective transfers of DC accounts to a DB plan are permitted under 1.411(d)-4(B)(1)(iv). [Note: I am not certain that that reg eliminates the issue of whether there is a prohibited transaction under Title I, but I doubt that anyone in the DoL cares.] The reg requires that the DB plan provide a minimum benefit (in exchange for the transferred DC amount) expressed as an annuity payable at NRA that is derived solely on the basis of the amount transferred. It seems to me that the minimum benefit would not be subject to 401(a)(4) under 1.401(a)(4)-11(B). On the other hand, if the participant is credited with a cash balance "account balance" and interest, there could be problems. If interest rates decline there would be an impermissible reduction in the benefit and if interest rates increase, the increase appears to be an accrued benefit subject to 401(a)(4) and 415. Link to comment Share on other sites More sharing options...
richard Posted December 5, 1999 Share Posted December 5, 1999 In response to Pax's 11/29 message: Item 1. Allowing employees to "rollover" DC account balances to cash balance plans allows them to lock in the investment return credited in the cash balance plan. It can be a fixed return, a return tied to an economic index (such as CPI or Treasury Bill rate), or a return tied to a financial markets index (such as the S&P). Either way, this gives the employee an opportunity to tailor his/her investment choice to his risk tolerance. Can the employee find similar products in the financial markets. In some cases (such as S&P index), yes. In others (such as CPI, not exactly although inflation bonds --- TIBs are a close surrogate). Also, there are insurance products than can accomplish some of these things. But do employees know of these choices -- some do more so than others. Also, there are commissions, expenses and other fees that must be borne by the employees outside of the cash balance plan. Item 2. Also, allowing employees to "rollover" DC account balances to traditional (non cash balance) DB plans allows them to guarantee a lifetime income for this amount of money. Yes, they can accomplish this by buying a commercial annuity. However, employers might offer "better" conversion rates in return for "long and valuable service." (And if not, the employee can simply buy a commercial annuity.) So, items 1 & 2 are essentially giving employees an additional option. Item 3. These moneys and benefits would be subject to PBGC insurance. There is no insurance for DC assets. Buying a commerical annuity does get insurance at the state level; this has historically been excellent (with certain notable exceptions), but not perfect. Item 4. Finally, this would be an additional way to get employees to appreciate what DB plans (either the traditional or cash balance variety) have to offer. Link to comment Share on other sites More sharing options...
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