individually directed cb

[abanky]

Has anyone heard/witnessed/ or know the legality of the ability to have participate directed cb plans?

would allowing a participant to individually invest their "hypothetical account" make the plan a cb, not a db?

Also, if it is possible, what are the administration headaches involved?

[AndyH]

Pre-PPA, it would violate 401(a)(26) because a separate asset pool constitutes a separate plan under 401(a)(26).

PPA muddies this somewhat and a January 2007 IRS Notice exempts some cash balance type plan designs. I'm not sure exactly how PPA affects the designs not described in the IRS Notice.

[Belgarath]

Caveat: I have done no research whatsoever for this response - I'm merely firing off random thoughts as they occur to me for the sake of discussion.

Have neither seen nor witnessed such a plan. I do not know if it is legal. But let's assume for the moment that it is.

I presume that the employer would keep the formula pretty low, since the employer is required to fund the necessary amount to provide the promised benefit. So if the participants pick stupid investments, employer is liable to make it up. If the formula is high, then successful investment return could cause 415 problems. So there would likely be a fairly low "floor" and then participants could reap additional benefits by successful investing, but in no event in excess of 415.

As long as the formula benefit is guaranteed, at least top heavy if not higher, then at least in theory I can't see why the IRS or Congress would necessarily object. But, as I said, I haven't looked into it.

[JanetM]

Oh horrible thought! Participant would chose the risky funds while the ER guarantees payment of defined amout. Not the spot I want to be in.

[david rigby]

If the individual CB accounts receive an "interest accrual" based on the investment return of the funds chosen by each participant, would that not foul-up "definitely determinable"?

[Blinky the 3-eyed Fish]

I think we have to wait until market rate of return is defined before it's determinable what is permissible in a cash balance plan.

[Guest mjb]

Pre PPA there were CB plans that allowed individual direction of the participant's account balance under the premise that the ee was only investing in the hypthetical account not a separate asset pool, e.g. employee could elect to invest his credits to receive a rate of return equal to S&P 500 which would be paid at termination but would not have funds invested in an S & P 500 fund. Plans are subject to certain limit such as reduction of 415 limits to max available at age of employee upon termination and the cutback rule. Some plans provided that benefits accrued in excess of 415 limits would be paid out under excess benefits plan.

Definitely determinable benefit rule only prohibits benefit accrual rate which is subject to discretion of employer. For example DB plan can allow benefits to be paid under a variable annuity.

Premise of allowing investment selection is that most ee will chose conservative investments, e.g. stable value fund while plan will obtain a higher rate of return e.g. 8% or more through active investing by professional mgrs.

[SoCalActuary]

The employer only guarantees the contribution credit and that the prior balance would receive the properly indexed amount. This is less risk than a traditional db. The challenge is to keep it from looking like a profit sharing plan, but that's the job for the ERISA counsel & the actuary.

[zimbo]

I have seen a few of these plans in action. There are a few firms I know of that aggressively market them. There is at least one major employer with many thousands of employees whose plan uses this concept.

My current personal opinion is that they are not valid pre or post PPA. That is because a participant's ultimate benefit level is at least partially dependent upon the performance of the funds that the participant chooses. Thus you no longer have a definitely determinable defined benefit plan.

Even when PPA defined market rate of return, it seems to me that the fact that the benefits are dependent upon investment performance chosen by the participant invalidates it as a Defined Benefit Plan.

Finally, even if it were legal, how would we handle a decrease in account balance when a fund portfolio chosen by a participant loses money causing a decrease in the year to year value of his cash balance account. How does that NOT violate 411, especially pre PPA?

Having said all of that, I know of no current or past IRS rulings one way or the other.

[Guest mjb]

Under Rev Rul 185, 1953-2 CB 202 benefits paid under a DB plan may vary based upon investment performance. The DDB rule only prohibits the employer exercising discretion in determing the amount of the benefits payable under the plan. In self directed plans the employees would have an opening account balance equal to the PV of their accrued benefits under a traditional DB plan and could select investments with a hypothetical return rate that mimics various indices such as S & P 500, LIBOR, Bond market index, T Bond, etc. The employees account balance could never decrease below the opening account balance plus additional employer contributions to the plan and benefits as an annuity could never exceed the 415 limit discounted to the employees attained age.

This is all pre PPA. Greater mind can opine on whether self directed DB plan are permissible under PPA.

[Blinky the 3-eyed Fish]

Post-PPA just mandates the cash balance can't fall below the total of the contributions, i.e. no negative return and that no less than a market rate of returned must be earned. That being said, unless something screwy comes out of the defining of market rate of return, I don't see that tying the interest credits to psuedo investments chosen by the participants violates the definitely determinable benefit. The investments are chosen in advance of the interest credits given. The document would define how the interest credits are earned. How is this not definitely determinable?

[Mike Preston]

I think the issue is a26, isn't it? If a plan covers 100% of the population and there are two choices and no fewer than 40% elect each choice it should work. Similarly, if at least 50 people elect each option, it should work. It was my understanding that this is the way the Bank of America plan was designed. But I could be misremembering.

[SoCalActuary]

My read on a26 is different. If there is a single trust that is used to provide the benefits for 40%/50 people,

that complies, but it is not the same as the benefit level of each person.

a26 is the "don't neglect me" provision, it is not the "don't discriminate" provision.

[Mike Preston]

I think the issue is that, in a sane plan sponsor's world, it goes out and actually purchases the theoretical investement/index. In such a case, it can be argued that you have separate asset pools and are subject to a26. Being subject to a26 is a non-issue, of course, if each of these separate asset pools has at least 50 bodies. Hence, the ability of a large plan, like BofA to get away with this design when a small firm would be unable to.

[SoCalActuary]

It is important to remember that the cb participant has a claim against all assets of the trust fund, regardless of the investments purchased. If the presumably sane trustee minimized investment risk by purchasing the assets to mirror the election, but the assets were all owned by the same trust account, then 401(a)(26) does not get violated. If the funds are not adequate to meet the benefit, then the sponsor must make further funding and/or the participant is stuck with annuitized payment streams, but they don't get to transfer the trust assets that match their interest credit option in the cb plan.

On the other hand, if each participant is given a separate trust to administer, and the benefits were solely derived from that separate trust, you would meet the plan design idea but completely violate a26. So the setup and the expectations of the participants must match the rules of DB plans to avoid dis-qualification, both of which are communication and consulting issues.

On a related note, PriceWaterhouseCoopers has been marketing these plans to very large lawfirms, where the market rate of return is essentially the same as the trust results.

For a few thousand dollars, maybe you could get Ira Cohen to explain it to you.

[Guest mjb]

There are no separate asset pools in a CB plan. The Participants select an investment option for the hypothetical credits in their "accounts", e.g., S & P 500, and the account will be increased by whatever the rate of return for the index during the period (but not reduced for a negative %). The plan invests its assets in accordance with its funding policy which can include hedging against investment options selected by participants but the plan's assets are not allocated to individual participants accounts. Hence no 401(a)(26) issue.

The assumption in a CB plan which permits investment options is that the participants will select conservative indexes such as T-Bill or Stable value funds which will allow the plan to keep the surplus, i.e., the difference between the rate of return earned by the plan's assets and the rate credited to the participants' accounts which will reduce the employer's contributions.

[Mike Preston]

Unless, of course, the CB plan is administered in a manner which ties the investments to the selections, thereby creating the a26 issue.

[AndyH]

I had the occassion to look at a recent PWCoopers designed plan, which was described as a "variable annuity plan". With all due respect to the creator, I (and our legal department) questioned how it satisfies numerous provisions of the law. We had a lot of questions and got no satisfactory answers.

Maybe it was more aggressive than what SoCal refers to. Maybe it was the same. But there were lots of unanswerd questions.

[zimbo]

I would be a bit leery of hanging my hat on a Revenue Ruling from 1953, although it can be valid. It just seems odd that a Defined Benefit Plan provides benefits based upon each individual participant's investment choices. This is a hybrid plan taken to it's ultimate conclusion and I believe it becomes more DC than DB. Also, I suspect that the market rate of return under PPA will be defined on a pooled basis and, if so, won't that render these extreme hybrids unworkable?

Post PPA, you also have the issue of adverse selection whereby the participant can never lose money from one year to the next thereby encouraging aggressive investment choices. Also there are funding challenges since the CB accounts can never lose but plan investments (which might be mirroring these accounts) can lose. Also, should a plan terminate, I believe that the cash value benefits need to be recast based on a 5 year average return. How in the world would that work with a participant directed cash balance plan?

[Guest mjb]

Its valid b/c DB plans with VA benefits have received determination letters after 1953. I dont understand your concern since the DDB rule only prohibits employer descretion in determining benefits but not a variable factor referenced in plan. See RR 74-385-- in DB plan DDB requires that benefits be determined under formula contained in plan document.

Whether a DB plan has DC characteristics is irrevelant. Under the IRC a DC plan must pay benefits based on individual account for each which does not exist in DB plan in which benefits are based on notional value of credits earned by individual. (See IBM case - District court held that CB plan was DB plan because participants did not have individual accounts.) DB plans can have DC characterics without violating IRC rules-e.g., CB plans can use DC integration rates, e.g 5.7% over SS wage base, to determine contributions as long as it passes 401(a)(4) general testing.

Adverse selection is not an issue because plan can monitor investment selection and hedge to avoid investment risk and will have gains from those ee who elect risk free investments such as T-Bills where plan has a higher investment return. Benefits are also limited to max 415 benefits discounted to current age.

I am not advocating such a plan but there is authority for establishing such a plan if the plan sponsor is willing to pay for the expert advice.

[AndyH]

That explains why I was looking at one. They were soliciting bids for actuarial and "compliance" services. Now I understand better why.

I guess these experts must get some $$$ for compliance services of their 1953 designs.

How about an 1853 design? Were there any 1853 revenue rulings to rely on?

(thinking about that brings back memories of Charlton Heston and talking Orangutans).

[Guest mjb]

a better memory is the 10 commandments and the parting of the red sea.

[Guest Guest99]

Of course, the variable factors here are solely as a result of the employee's individual investment choices among a series of preselected funds (much like a self directed DC Plan). Thus you have a participant's ultimate benefit level largely determined based on the actual performance of funds chosen by a participant. Sure, the plan document can refer to them as "notational" but the point is that the employee directly bears the risk of investment performance and that intuitively (IMO) takes it out of the realm of Defined Benefit Plans.

Of course, the IRS has never ruled definitively on these, so who really knows? Those designing and promulgating these hybrids of hybrids may in fact have the last laugh. But, I see it as a risky proposition.