Cash Balance Safe Harbor Interest Rates

[Guest D.W.]

I have a plan (actually two) where the prior actuary designed the plan so that the interest crediting rate was initially equal to one of the safe harbor indices (plus margin where applicable).

In the case of those Plans, as interest rates dropped, the prior actuary put in a fixed floor rate in the plans so that no violation of the 133 1/3rd rule would occur if the interest rates dropped.

Fast forward to today, the regulations for rates provide a similar or same list of safe harbor rates, and under 1.411(b)(5)-1(d)(6) describes that a plan violates the safe harbor if it uses any combination of the greater of rates in the safe harbor (which are those bond indices, 3rd segment rate, and a fixed rate that has the comment [RESERVED] after it).

The rules about acceptable combinations of interest rates in 1.411(b)(5)-1(d)(6)(ii) describe acceptable combinations of bond rates with an annual floor, and the comment after it is again [RESERVED], and no guidance is provided.

The past couple of years, the fixed rate specified due to the 133 1/3rd rule is higher than the t-bill and short t-bond rates plus their margins (it is about 2% - the floor in each case for the interest credit rate).

Does anyone know when the powers that be are going to specify an acceptable annual floor, or if they will, under 1.411(b)(5)-1(d)(6)(ii)?

[Effen]

I am not sure I understand your concern regarding the 133% rule. Each year stands on its own. The 133% rule is typically not an issue with fluctuating interest rates in cash balance plans. I think your bigger issue might be 411(d)(6) since each time you change the rate you need to protect the old rate on those past accruals. That seems like it could get very complicated.

I think the regs indicate that a 5% rate is acceptable. If your fixed rate is higher, I don't know if any solution exists.

[John Feldt ERPA CPC QPA]

The proposed regulations allow a fixed 5% rate. Since these are not final regulations, you might be able to use a higher rate and say you used good faith compliance that your rate did not exceed the market rate? Some say the final regulations might allow a fixed rate of 5.5% (the 415 interest rate). We'll see soon, hopefully.

[Guest D.W.]

I am not sure I understand your concern regarding the 133% rule. Each year stands on its own. The 133% rule is typically not an issue with fluctuating interest rates in cash balance plans. I think your bigger issue might be 411(d)(6) since each time you change the rate you need to protect the old rate on those past accruals. That seems like it could get very complicated.

I think the regs indicate that a 5% rate is acceptable. If your fixed rate is higher, I don't know if any solution exists.

These are both large plans with complete cross sections of employees from age 21 to past NRD, so the rate required to satisfy the 133 1/3rd rule generally doesn't change. Initially, in both cases, a safe harbor rate was used (which was, at the time, much higher than the 2% or so minimum rate needed to pass the 133 1/3rd rule). When the plans were tested by the prior actuary to determine a rate where the plan wouldn't pass the 133 1/3rd rule, the rate was added to the documents as a floor, and we inherited their language when we took over the plans. Those interest credit rates are now, to my understanding, part of the accrued benefit - as you say.

On the face of it, I think any reasonable person would never describe a 2% +/1 a couple of tenths to be a rate that was devised to provide excess interest crediting to participants, but the final regulations as they stand now appear to be silent when a combination of a safe harbor rate (for example 1 year treasuries plus 100 basis points) and a floor are used, but....

thanks for reminding me to look in the proposed regulations. The proposed regulations allow a safe harbor rate plus a floor of up to 4%. That's exactly what I needed to file away in the document folder.

[My 2 cents]

I thought that the interest credit is this year's rate times the balance at the beginning of this year, without regard to how the beginning balance was arrived at (assuming that there have been no changes to the method used to calculate the interest crediting rate - which would normally require grandfathering). Example: calendar year plan specifies that the interest crediting rate for a plan year would be published index X as of a given date (such as the last day of the prior plan year). If last year's value for index X was 5% and this year's is 4%, I thought that the account was to be credited this year at 4%, irrespective of the value for index X in any prior year in which there were pay credits. Is this not so?

It was also my understanding that there are no 133% accrual issues unless the cash balance plan uses pay credit percentages scheduled to increase for a given participant from year to year. For a given pay credit schedule, you need to pass the 133% rule for any imaginable hypothetical employee, not just the current population. So if the pay credit is 3% this year, 4% next year and 5% 6 years from now, there is a certain minimum interest credit rate necessary to establish that the 5% credit in 6 years is not greater than 133% of this year's 3% credit (both measured based on accumulation to NRA). I think it is a fair question, deserving of a proper answer, as to what happens if the pre-established plan interest credit rate needed to make the pay credit schedule meet the 133% accrual rule winds up exceeding a fair market rate. I saw a cash balance plan once that had a pay credit schedule that rose, service band to service band, from 3% for new hires to 15% for people with something like 35 years of service. They needed an interest crediting rate over 6% to meet the 133% accrual rule. What would happen now?