Interest Credits in Cash Balance Plans

[Guest SamFischer]

Is anyone aware of authority that permits a cash balance plan to index the amount of interest credits annually allocated to participants' "accounts" to the performance of the plan's investments? (e.g., the better the plan's investments do, the higher the interest credits; if the investments lose money, zero interest credits) Thanks, SF.

[Everett Moreland]

There are old revenue rulings (still good law) that prohibit a defined benefit plan from basing the benefit on the plan's investment return.

[FAPInJax]

My understanding is that several of the 'large' actuarial firms doing cash balance plans are allowing participants to select their funds (similar to a 401k) and recognizing the respective earnings of the funds.

I believe the prohibition mentioned does not apply to cash balance plans because the balances are converted into accrued benefits following a strict plan document definition.

I am sure others who are administering these plans will offer their opinions as well.

[Everett Moreland]

Well, I have to correct myself. Revenue Ruling 78-403:

"Rev. Rul. 185, 1953-2 C.B. 202, provides that benefits will not fail to be definitely determinable merely because they vary with the investment experience of the plan assets or with a generally recognized cost of living index."

[Guest Keith N]

Regarding Frank's comment, I have heard of this as well. My question related to this method is "why"? If you are going to credit the employees with the earnings rate of the fund, why do it in a cash balance plan? Why not just use a DC plan?

If you give them some guaranteed floor, but credit them with higher returns if the investments do better, the employer is passing the one of the major advantages of the cash balance plan off the employees and again I ask why?

Does anyone know why a company would do this? Unless they are doing it purely to attract employees and really want to give them the best of both worlds (good returns in up markets and good returns in down markets), I haven't been able see any advantages for the company.

[MGB]

The practice that Frank is referring to has nothing to do with the actual investments in the plan's trust. The cash balance participants have the option of choosing "investment options" in mutual funds, money market, etc., for the purpose of determining their crediting rate, but the money is not actually invested in those funds. The employer is betting that their professionally-managed investments will do better than the poorly chosen selections of the participants. There can also be accounting gains from doing this. The first large firm to do this was NationsBank a few years ago. In that scenario, they allowed participants to transfer their 401(k) balances to the new cash balance plan and continue to get interest credits based on the investments that they had under the 401(k) (some of which were internally-managed funds not open to the public). However, the actual investments of the plan did not stay in these funds.

Everett's reference does not apply to a DB plan.

Sam, the plan cannot give interest credits derived from the actual investment return of the trust fund. However, some plans do give additional interest credits when investment returns warrant it after-the-fact through plan amendments. That approach is allowable if it is not done every year. If it is done every year, it becomes part of the plan through continued usage and, therefore, becomes not allowable.

[Everett Moreland]

MGB: Revenue Ruling 78-403 is a DB ruling. The ruling seems to be saying that the statement I quoted above applies to DB plans.

[mbozek]

Rev rul 185 of 1953 applies to pension plans and permits variable annuity type benefits based upon the performance of the assets as not violating the definitely determinable benefit rule. I have reviewed several DB plans that permitted an election of a varible annuity which received IRS approval.

[Everett Moreland]

Interestingly, 1.401(a)(9)-6T appears not to allow the variable feature of the benefit to continue during pay out. The Oregon Public Employees Retirement System has such a feature (variable during employment and during the pay out phase). That's probably one reason why the IRS is giving governmental DB plans a break under the 401(a)(9) rules.