What is my lump sum?

[JBones]

Our client (a takeover plan) is terminating their cash balance plan. The plan was effective 1-1-07. The plan provides for annual hypothetical interest credits based on a fixed interest rate of 5%. Actuarial equivalence in the plan is 5.50% pre and post retirement interest with 1994 GAR post retirement mortality. 417(e) distributions are defined in the document as being based on applicable interest and mortality.

It’s my understanding that the proposed regulations provide in 411(a)(13) that a cash balance plan can pay out lump sums based on the hypothetical accounts without violating 411© or 417(e). Separately, 411(b)(5) provides that the accrual rules of 411(b) are not violated as long as, among other things, the guaranteed rate of return does not exceed a market rate. I realize the regs caution against adopting interest rates other than those specifically named, but unfortunately, I’m stuck with the design dropped in my lap.

Based on my reading of the regs, the fixed rate of 5% may cause the plan to violate the 411(b), depending on future guidance, but the issue of paying out the lump sum should not be affected by the fixed rate and is not a “market rate of return” issue.

Am I correct in my understanding? Can I pay out the hypothetical balances rather than the 417(e) equivalent? If not, won’t I still have a potential 411(b) issue? Or does the 417(e) distribution language in the document overrule all of this and require lump sums to be based on the applicable interest and mortality? Is anyone else designing new cb plans using fixed interest rates?

[JBones]

A short version of the question above: Does a cash balance plan using a fixed interest crediting rate of 5% prevent the ability to pay out the hypothetical balance as a lump sum based on the proposed regulations?

[John Feldt ERPA CPC QPA]

I think it's okay unless the 5% exceeds the market rate. So yes, but maybe no.

We are expecting guidance from the IRS soon regarding a fixed rate. The current guidance provided by the regulations is "reserved" - so not much to go on there.

[JBones]

I think it's okay unless the 5% exceeds the market rate. So yes, but maybe no.

We are expecting guidance from the IRS soon regarding a fixed rate. The current guidance provided by the regulations is "reserved" - so not much to go on there.

I thought that the market rate was an issue related to 411(b) accrual rules rather than lump sum issues (411(a)(13), 411© and 417(e)). If that is the case and I pay out the lump sum based on 417(e) assumptions, won't I still have a problem with the accrual rules? Also, if I pay the lumps sum on 417(e) and it turns out 5% does not exceed market rate based on future guidance, did I violate the terms of the plan by overpaying participants?

[John Feldt ERPA CPC QPA]

Perhaps my understanding is flawed:

1. If the plan satisfies all of the PPA 'applicable defined benefit plan' or 'lump sum based benefit formula' plan requirements, then the plan avoids the issue of age discrimination due to the interest rate, and the lump sum payable is equal to the balance of the account (meaning it is not subject to 417(e)(3)). Of course, if the plan is top heavy and unless the TH mins are provided in the DC plan, the top heavy minimums are required to be determined when benefits are paid, and those TH minimum benefits are subject to 417(e)(3), presumably.

2. If the plan does not do what is listed out under PPA for a lump sum based plan, then 417(e)(3) does apply, so the whipsaw calculations are needed, and the plan is considered to be age discriminatory. The way I read it is that a cash balance plan automatically violates the age discrimination rules if any of these are true: 1) the plan provides an interest crediting rate that is higher than the market interest rate, 2) the plan does not preserve capital (allows an overall negative interest credit to the account), 3) the plan does not follow interest rules upon plan termination, or 4) the plan violates any conversion restrictions.

Currently, one section of regulations that came out due to PPA states that a lump sum based plan may provide for an interest rate that cannot exceed a market rate, and that such rate may be a fixed interest rate for crediting to the account. The guidance provided that the market rates allowed can be indexed rates as described under Notice 96-8 are okay and that the corporate bond rate and the 3rd segment rate (and any lower rate) is okay. Then, as for the fixed rate, the IRS literally marked that section of the regulation as "reserved" and they asked for comments regarding the fixed rate, and presumably they are in the process of writing such regulations at this time.