Multiple Crediting Rates

[John Feldt ERPA CPC QPA]

In a small cash balance plan (a DB/DC combo design to minimize employee benefit costs), suppose that the plan's interest rate credit is written to provide for the NHCEs the greater of the 3rd segment rate under MAP21 or the 30-year treasury rate. Then, for the HCEs, it provides the lesser of the 3rd segment rate under MAP21 or the 30-year treasury rate.

Perhaps define the actuarial equivalence as a fixed rate (for purposes of this discussion).

Problems? The HCE benefits would grow less quickly than the NHCE benefits. Of course this helps with 401(a)(26) and 401(a)(4).

Has anyone attempted this?

Has anyone attempted this and received a D letter?

Has anyone attempted this, been audited, and survived the audit?

[John Feldt ERPA CPC QPA]

Okay, maybe this will spark a reply:

How about doing the above except we also define the interest rate for actuarial equivalence purposes for HCEs as 5% with a higher rate (like 8.5%) for NHCEs for determining the accrued benefit in the cash balance plan?

Or how about also defining A.E. with GAM71 mortality for the NHCEs and something like GAM83 Female for the HCEs?

With all of this, 401(a)(4) would be really humming along, right? Just hoping for some comments/feedback. Is ak2ary still out there?

edit: typo

[ubermax]

well to be honest it sounds to me like you're trying to "game the system" - that's OK but first you should do your homework and check the CB regs to see if different crediting rates by HCE/NHCE status is cricket , different AEQ factors by status doesn't smell right but I'd have to do some research to prove it out and don't have time now .

a response , not the one you wanted but that's it - good luck !!!

[John Feldt ERPA CPC QPA]

Appreciate the response. I did not find this issue addressed in the proposed CB regulations or in the portion that was finalized. Awaiting the final cash balance regulations before truly considering implementing anything of this sort. Hoping to hear if anyone else might have jumped into this opening in the ice first (I don't like being eaten by an unseen walrus). The AE was just a carrot to illicit some reply.

If the conversion from the cash balance account into an accrued benefit for the NHCEs is a more favorable conversion than it is for factors that apply for the HCEs, how does 401(a)(4) or 401(a)(26) or 411 or other code/reg prevent a plan from doing this? I don't see it yet, but perhaps the final cash balance regulations will tell us something.

[Effen]

My first reaction was the same as ubermax....pigs get fat, hogs get slaughtered... I would say, why push it, but I know lots of people make a nice living pushing things that aren't cricket and just fix them if/when the IRS creates a rule to stop them.

Anyway, if you look at this from the other direction, what stops you from creating a traditional plan where the lump sum for an HCE is determined using 1% and RP 2000 projected to 2050 by BB, and lump sums for NHCEs are based on 417(e) rates? Would you argue that is acceptable? I know you are going the opposite direction, but you are ultimately doing it to get more $ for the HCEs. Couldn't the IRS use the same argument to attack your potential design?

Wouldn't the conversion rate be considered a right and feature that would need to be tested? You may say, fine, the HCE is getting a lower monthly benefit, so it is all good...but wouldn't you need to normalize that benefit for testing somehow?

[John Feldt ERPA CPC QPA]

I've actually seen a competitor's plan where the A.E. for the plan was 3% so the targeted lump sums for the HCEs were reaching the maximum 415 lump sum amount without the accrued benefits reaching the 415 annuity limit. We've still not done any this way, but our reactions were similar to yours, but in addition was the question of whether or not the 3% is a reasonable rate for the definition of A.E.

I don't see 1% as a reasonable rate in your example above, but someone out there has used 3% A.E. to allow the tested accrued benefits of the HCEs to be smaller. But again, I thought the A.E. definition had to be reasonable, so that's why I would hesitate before going as low as 3%.

On the cash balance side, the IRS has already explained to use what interest rates are allowed for crediting, so why not allow the NHCEs to have better conversion factors for their accrued benefits than the HCEs.

Currently, a combined-tested plan is not required to normalize the DB plan benefits due to lump sum differences because of its A.E. definition when compared to 401(a)(4) assumptions for testing. You're not suggesting the 401(a)(4) regulations be modified to do that?

[Effen]

Good point about the reasonableness issue, but continuing your argument, how do you argue that it is "reasonable" to use different rates for different groups inside the same plan? Why is it "reasonable" to use 5% for HCEs and 8.5% for NHCEs? Have you seen studies that NHCEs are better investors and generally earn more than HCEs?

"the IRS has already explained to use what interest rates are allowed for crediting, so why not allow the NHCEs to have better conversion factors for their accrued benefits than the HCEs." - because they are not stupid.

In reality, there are probably people out there doing what you are suggesting. If you are comfortable with the design, just make sure the client is fully aware of the potential problems, and let them make the choice. It is the client who has the problem if it blows up, so make sure they are willing to take the risk before you proceed.

[John Feldt ERPA CPC QPA]

Certainly not doing any designs this way, merely gathering unverifiable information from mostly anonymous sources here due to an outside plan we came across but we declined to administer.

Suppose the employer has a stand-alone cash balance plan and they want the NHCE balances to grow at a higher rate, but to minimize increasing plan costs they want the HCE balances to grow at a slower rate. One could argue that the plan could either be designed to simply provide much smaller pay/service credits for the HCEs and apply the higher crediting rate for everyone, or provide the low crediting rate to everyone and provide higher pay/service credits for the NHCEs? If the employer had this as a goal, is this the route you would recommend?

Suppose an employer has a stand-alone cash balance plan and wants to generously encourage annuity payment options, but not for the larger benefits payable to the HCEs. Would it be unreasonable to do this only for the NHCEs? No. Perhaps you are suggesting that it would not be reasonable to encourage annuity forms of payment through the plan's definition of actuarial equivalence? I could see that, but if so, how would any such option not be, by definition, a form of actuarial equivalence to convert it into that annuity?

"Have you seen studies that NHCEs are better investors and generally earn more than HCEs?" This question is off target if we're trying to argue regarding code/regulation/guidance or other IRS thinking on the concept. That's probably not the intent of your question, so no, I have not seen nor am I in need such a study (although I've heard that the best way for an overfunded doctor/dentist/lawyer plan is to have the doctor/dentist/lawyer handle all of the investments).

edit: typo

[david rigby]

Initially, I thought this was a pretty obvious BRF problem. Am I missing something?

[John Feldt ERPA CPC QPA]

Does such a design fail on a benefits, rights, or features basis? Do the NHCEs have better BRFs than the HCEs when designed like this?

[david rigby]

Oops, I read it backwards.