Cash Balance Plan Minimum Interest Crediting Rate

[Guest aciepluch]

Cash balance plan provides for interest credits at the five-year treasury rate. In connection with a determination letter request, the IRS has directed the plan to retroactively include a minimum interest credit rate in order to satisfy the minimum acrrual requirements of Code Section 411(b)(1). The minimum rate that the IRS has demanded is greater than the actual interest credit rate that the plan used for four of the last six years, so the Company is faced with providing increased interest credits on a retroactive basis.

We took the position that the plan satisfies the 133 1/3 rule using an "accrued to date" method, as described in 401(a)(4) regulations. The IRS has rejected our position, although we have not yet heard its explantion as to why.

Has anyone else: (1) faced this type of demand; (2) convinced the IRS that the accrued to date method is a viable alternative in this type of situation; or (3) had any luck with any other position?

Thanks in advance. .

[ak2ary]

IRS is taking this position with respect to all cash balance plans that have increasing pay credits. They have forced even the largest of employers to adopt minimum interest credit rates.

I don't see anyway to use an accrued to date methodology to show that you met the 133 1/3rd rule. 411(b) and 401(a)(4) are different and serve different purposes. Besides, the 133 1/3% rule looks at the year by year pattern of benefit accrual, only the fractional rule has an accrued to date element to it

The only way I have seen plans get around this is by reducing via amendment, the future pay credits. If the violation has already happened however, you're out of luck

You may also be able to use a higher interest rate and adopt prospectively so that you don't have to make retro corrections

Example: IRS says your minimum interest rate must be 2.5% retro to the effective date. You may be able to accomplish the same thing by leaving past interest credit rates alone and using 3 or 4% for 2007 or 2008 and later. You may already have people who failed and were paid out and you may be stuck

You should be aware that the IRS calcs often come up with a minimum that is significantly greater than it needs to be. You should recalculate the minimum interest rate necessary before your client agrees to anything

Interestingly enough, I have heard that, in some cases, as step two, they have gone on to say that, now that you have a minimum interest credit rate, you no longer have a safe harbor rate under 96-8, and you are subject to whipsaw etc...

[Guest Kabert]

Does the IRS's recent guidance (revenue ruling?) on backloading help in your situation?

[Guest aciepluch]

Does the IRS's recent guidance (revenue ruling?) on backloading help in your situation?

Although the new guidance recognizes that there is more than one way to satisfy 411(b), it doesn't specify that an "accrued to date" method is one of them.

[Guest TooMuchFreeTime]

I'm confused.

It was my understanding that cash balance plans were tested against the accrual rules based on the basic compensation credits; NOT the interest credits. I've seen the Service approve plans based only on a fixed % compensation credit, wholly ignoring the interest rates.

The only issue I've seen them take with the interest rates was where an investment-based rate with the potential to go negative was used. In this instance, their concern was that a prohibited reduction in benefits might occur. We argued the operation of such a rate was identical to a permissible variable annuity. The Service agreed, and we all moved on with our lives.

Further, with respect to the appropriate rates, the new regulations indicate that they're more concerned about the use of an interest crediting rate that is TOO HIGH. The only dicussion I've seen of a minimum interest crediting rate is a "preservation of capital" type clause that would even allow the use of a negative interest crediting rate ( provided that the account balance would never dip below the sum of all prior earnings credits).

Does this sound right to anybody else?

[Guest aciepluch]

I'm confused.

It was my understanding that cash balance plans were tested against the accrual rules based on the basic compensation credits; NOT the interest credits. I've seen the Service approve plans based only on a fixed % compensation credit, wholly ignoring the interest rates.

The only issue I've seen them take with the interest rates was where an investment-based rate with the potential to go negative was used. In this instance, their concern was that a prohibited reduction in benefits might occur. We argued the operation of such a rate was identical to a permissible variable annuity. The Service agreed, and we all moved on with our lives.

Further, with respect to the appropriate rates, the new regulations indicate that they're more concerned about the use of an interest crediting rate that is TOO HIGH. The only dicussion I've seen of a minimum interest crediting rate is a "preservation of capital" type clause that would even allow the use of a negative interest crediting rate ( provided that the account balance would never dip below the sum of all prior earnings credits).

Does this sound right to anybody else?

While that may be true with a fixed forumula plan, it isn't true with a graded formula plan (e.eg., age-, service- or points-graded). In this case, the pay credits increase with age. I understand that the IRS's view is that the plan must comply with the accrual rules under any conceivable fact pattern and that a graded cash balance plan with only a variable interest credit won't meet this standard in a low interest rate enbironment, unless the highest rate is no more than 133-1/3% of the lowest rate that could apply to a participant.

ak2ary: On your comment "You may also be able to use a higher interest rate and adopt prospectively so that you don't have to make retro corrections"--have you heard of the IRS allowing this?

Thanks to all for your input.

[ak2ary]

Yes as long as the "invalid accrual" has not already accrued..so if it is a scheduled future accrual that fails, you can adjust the future interest credits to make it work. We have done it and gotten favorable DL's

[SoCalActuary]

Yes as long as the "invalid accrual" has not already accrued..so if it is a scheduled future accrual that fails, you can adjust the future interest credits to make it work. We have done it and gotten favorable DL's

Any chance we could see an example?

[ak2ary]

Age....... Pay Credit

21-24.... 3%

25-29.... 4%

30-34.... 5%

35-39.... 6%

40-41.... 7%

42-44.... 8%

45-49.... 9%

50-54.... 12%

55-59.... 16%

60-64.... 20%

Attached is an excel file that illustrates the two possible solutions I discussed above for this pay credit formula

The solution reducing future pay credits only works if no one has accrued at the offending level.

133__Example.xls