Cash Balance Market Rate of Return

[Dennis Povloski]

I'm reading proposed regs for cash balance plans, and they have a list of options for acceptable Market Rates of Return. They were nice enough to reserve sections for Equity-based rates and fixed interest rates, so basically we have the 3rd segment rate, various treasury yields, and eligible cost of living indices.

I'm trying to wrap my brain around how these interact with the PPA funding rules, and just speaking in very gross generalities:

*If we use the 3rd segment rates, our target normal cost can be higher than the contribution credits because contributions are projected at the 3rd segment rate, and discounted using potentially all 3 segment rates (assuming 1st and 2nd segments are lower).

*If we use any of the treasury yields, our target normal cost can be lower (project out at a low treasury rate and discount at higher segment rates).

*I'm assuming that the eligible cost of living indices are along the lines of many of the treasury yields, so same problem.

Would anyone be willing to give your thoughts on how you are selecting interest credit rates for your new cash balance plans?

At first, I leaned towards using the 3rd segment rate because it seems to produce a target normal cost that is close to the contribution credit, although it seem silly to have a funding cost larger than the contribution credit. If I use a treasury rate, the target normal cost seems to come out extremely low because there is a large disparity between the treasury rates and the segment rates. I suppose that as time progresses, you have enough range in the maximum to make up for any shortfall, so maybe that's the way to go.

Anyway, thanks for humoring my ramblings.

[John Feldt ERPA CPC QPA]

Well, FWIW, we have mostly micro-small plans (under 30 ees). We have been pondering much the same question. We hoped that the guidance (issued December 28th) would provide the silver bullet, including a fixed rate, but the bullet was a blank.

Generally, we'd like to explain the funding of the plan to the client using a 'recommended contribution' style in 2008, something in-between the low minimum funding amount but not as high as the maximum amount (cushion) - like an individual aggregate method. We will show both min and max, but add an explanation of the consequences of going to either extreme.

We would like the minimum contribution to still be somewhat flexible, and not require the current cash balance credit to be equal to the normal cost every year.

Also, unless the HCEs are accruing one-tenth of the dollar limit when the plan is started, we like to recommend overfunding the plan slightly. That leads us to our current conclusion: We think a lower cash balance crediting rate (lower than the funding rate) will work best from a funding standpoint. So we are still using the 30-year treasury rate for the crediting rate. We think the 30-year rate will stay less than the 3rd segment rate pretty much all the time.

On the flip side, we have seen data where a higher interest crediting rate can help the plan design from a testing standpoint, 401(a)(4). So we will probably not always be setting up plans with the GATT rate as the crediting rate.

I'm no actuary, so I'd appreciate any truly qualified comments on this as well.

[Effen]

Prop Reg. 1.411((b)(5)-1(d)(8)(ii) Adoption of long-term investment grade corporate bond rate or safe harbor rate. An amendment to a statutory hybrid plan to change the interest crediting rate for future periods from an interest crediting rate described in paragraph (d)(5) of this section to the interest crediting rate described in paragraph (d)(4) of this section does not constitute a decrease of an accrued benefit and, therefore, does not violate section 411(d)(6). However, an amendment described in this paragraph (d)(8)(ii) cannot be effective less than 30 days after adoption and, on the effective date of the amendment, the new interest crediting rate cannot be less than the interest crediting rate that would have applied in the absence of the amendment.

Assuming the current accumulation rate is based on the 30-yr treasury rate, since the 3rd Segment rate stuff is in "(d)(4)" and the 30-yr treasury (old standard) is in "(d)(5)", doesn't this mean that the Plan needed to be amended by November 30, 2007 in order to use the 3rd Segment rate starting 1/1/2008?

Seems to me since they didn't release this until 12/28, it would be difficult to use the 3rd segment rate as of 1/1/08. I guess you could change it mid year, but that seems like a pain. I suppose we need to keep using the 30-year treasury rate for 2008.

Am I missing something?

[zimbo]

I think you read it correctly. Another curious item from that reg section is that it appears that you cannot amend the interest crediting rate to be LESS than the current rate. What does that really mean. If you wish to change from a fixed rate to a 30 year Treasury rate, does that clause prohibit such a change?

[AndyH]

Don't they have until the proposed effective date of 1/1/09 to fix these bizarre things?

[Effen]

Maybe, but even if they fix it before 1/1/09 what are we to do in the mean time? I have clients who would like to make distributions and I need to pick an accumulation rate.

Since most of ours use the 30-yr Treasury rate, it seems the only reasonable way is continue to use the 30-year treasury for 2008, then change to 3rd segment (maybe?) in 2009. It may depend on what the relative value disclosures look like.