2 cash balance questions

[Guest lerieleech]

1. From what I have seen, the new funding rules in Title I of PPA 06 apply to cash balance plans as well as others. Is this correct?

2. Notwithstanding anything in PPA 06 about interest credits being within a market rate of return:

Has anyone ever heard of a cash balance design that allows for individually invested accounts equal to the hypothetical accounts, where the rate of return is then somehow justified in the document?

I don't know all the specifics, but apparently, for example, if a participant gets a 20% return on their account for the plan year, then somehow there is a mechanism in the document that gives them 20% on their hypothetical account.

Seems very far out there, as well as contrary to the definitely determinable rules, to me. But a contact mentioned it.

[Guest Steve C]

1. I think you're right - I'm not aware of any Title I exemption for cash balance (nor would I expect one).

2. I've never worked with an "individually directed" cash balance plan, but I'm vaguely aware of one. It was adopted by an ex-employer of mine several years after I had left. I had heard that Ira Cohen consulted on the design.

I'm unfamiliar with the actual design details, but I've always imagined that participants were allowed to construct their own interest crediting basis by allocating among a number of indices. Could be wrong of course - just guessing.

[SteveH]

I know of one self directed cash balance plan also. I can't help with specifics either, but yes there is at least one out there.

[zimbo]

There are such cash balance plans out there. I was involved in a peripheral way with one adopted by a large accounting firm.

It operates much like a Daily Valued DC Plan but everything is hypothetical. The hypothetical contribution is hypothetically contributed x days after each pay period and is hypothetically invested in your selected funds.

The question for which I never received a straight answer is whether a decline or even a no change in investment portfolio would cause a prohibited 411 reduction in accrued benefits from one year to the next. IN other words, could your account remain flat from 1/1/05 to 1/1/06 without causing a prohibited reduction in the monthly normal retirement benefit?

[Penman2006]

BTW, what is "market rate of return"? Is that term defined somewhere?

[SoCalActuary]

The answers to all these questions are in the conference report, starting about page 155.

You can have a negative investment return and a reduction in account balance, as well as monthly equivalent benefit.

You can base the benefits on a market index, allowing a negative rate.

You can base the benefits on a market rate of return, such as the posted rates for different trasury maturities

or on corporate bond rates.

[JAY21]

Hmmmm.....so the employer is on the hook to "guarantee" a potentially negative market return. They can probably live with that !

[ak2ary]

1. From what I have seen, the new funding rules in Title I of PPA 06 apply to cash balance plans as well as others. Is this correct?

2. Notwithstanding anything in PPA 06 about interest credits being within a market rate of return:

Has anyone ever heard of a cash balance design that allows for individually invested accounts equal to the hypothetical accounts, where the rate of return is then somehow justified in the document?

I don't know all the specifics, but apparently, for example, if a participant gets a 20% return on their account for the plan year, then somehow there is a mechanism in the document that gives them 20% on their hypothetical account.

Seems very far out there, as well as contrary to the definitely determinable rules, to me. But a contact mentioned it.

Revenue Ruling 53-185 provides that a plan will not fail to have definitely determinable benefits simply because each participant's accrued benefit is multiplied by a fraction the numerator of which is the rate of return on some "variable annuity"; the denominator of which is the plan's assumed return (actuarial equivalent). The ruling goes on to say that the plan's actual rate of return can be used as the variable annuity. Thus, in a cash balance plan where the pay credit for the year is deposited on 12/31 of each year, the total plan assets will always equal the value of plan assets. Further, in the typical variable annuity example, rather than define the accrued benefit in terms of a hypothetical account, it defines it in terms of a career average pay benefit where the pv of the accrual matches the pay credit. They claim that this gets around the whipsaw because, they claim the plan is not a CB plan and hence not subject (even tho benefits accrue in exactly the same manner as a cash balance plan)

Recent variations include a variety of investment options for assets, with a separate variable annuity depending on the investment option chosen. This only works if each option has at least a 401(a)(26) group electing it. I have recently heard that a variant of this design is allowing for individual investments, but how it avoids the separate benfit structre restrictions of 401(a)(26) is beyond me...my guess is that they simply claim it doesn't apply in the same manner(exactly) as they simply claim whipsaw doesn't apply.

Interestingly, variable annuity plans got themselves a statutory basis in ppa by getting an exemption from the "not less than zero" return rule

[AndyH]

I happen to have a sales proposal by another firm that I'm looking at that is not detailed but it does appear to be a dc plan plus a self directed cash balance plan. There are about 50 participants that would be covered. There is of course little detail, but among the exhibits are growth charts that use an assumed 8% growth rate.

This is represented as a "proprietary" design. The words "self directed" and "virtually unlimited investment options" appear to include the CB component.

Any opinions on the validity of such a design?

From the comments above, it sounds like it might fly. Agree/disagree?

[SoCalActuary]

Variable annuity contract for cash balance plan - Andy, I salute you for putting the two concepts together.

Now the PPA wording makes sense.

[SteveH]

With a self directed cash balance plan isn't the plan sponsor running the risk of participants going for broke with their investments trying to earn as much as possible because in the end the plan is going to have to pay them their guaranteed account balance plus the interest credits? Then on the flip side if the employee self directs his account very well, there is no financial pay off for the employee because the employee will only get paid his guaranteed account balance plus the interest credits? I just don't see the point of self directing a cash balance plan.

If an employee makes $50,000, the plan has a 10% of pay formula with an interest credit of 5% and the employee quits 1 year later aren't we looking at a distirbution of $5,250? Regardless of what the underlying investment has done? So what is the point of self directing? Just to make the participant feel like they are in control?

The kicker on this type of plan is that you assume the investments are going to earn more than 5% so the $5,000 that you allocated for the participant is going to cost less than $5,000. There is no market risk for the participant, the plan bears all of the market risk and therefore they bear all of the market reward. I dunno, maybe I am confused, but I just don't see the point of self direction.

[SRM]

I think the interest credits in the self directed cash balance plan idea are not a fixed rate, but instead something tied to the investment return on each self directed account. The new law may apparantly open the door to this design (although I think there are more than a few issues still to be addressed before the design is anything less than very aggressive). The interest credit could be something along the lines of:

1. annual interest credit equivalent to yield on model portfolio selected by participant from plan's approved model portfolio list. The model portfolio list would consist of the asset allocations corresponding to each participants self directed investment account.

2. the cumulative interest credits could not be less than 0.

The regulatory issues that I see as needing to be addressed before this is a feasible design are:

1. 401(a)(26) - does this create a separate benefit structure for each participant. Are funds from all accounts available to pay all benefits?

2. Benefits, Rights and Features - Are all investment advisers and portfolios available to NHCE?

3. Non Discrimination Testing - What are the mechanics of general testing this design if the interest credits are all over the board (i.e. what interest rate is used to increase CB to retirement age and convert to accrued benefit to test on benefits basis)?

4. 415 Limits - How are 415 lump sum limits calculated based upon the new law (the plan rate portion) when the interest credits are so variable?

These are just some regulatory issues that could arise, not to mention some practical issues related to keeping a relatively predictable minimum required and maximum deductible contribution range in an environment with individually directed investment accounts.

[SteveH]

Wow I really don't think I would be comfortable setting the interest credit at whatever the employee earned in their self directed account.

Then again I didn't think that "each participant is their own group" in a new comp profit sharing plan would ever fly either. I still don't use it, but I think I am in the minority on that one.

Maybe it is a similar concept, it's a tiered interest crediting cash balance plan. If it can be done, who rolls it out first?

Can I get internet access and a VRU with that?