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Transitional Guidance For Cash Balance Plans

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The Internal Revenue Service has issued a new notice providing transitional guidance for cash balance plans. It also announced that its moratorium has been lifted on issuing determination letters regarding these plans.

A cash balance plan is a defined benefit plan that calculates benefits in a manner similar to the way benefits are calculated for defined contribution plans. Each participant has a hypothetical “account,” but participants do not direct investments, and the employer bears the plan’s investment risk.

In the past, these plans have been controversial because some claim that cash balance plans illegally discriminate against older workers. In fact, cash balance plans became so controversial that the Service announced in early 2003 that it would not process determination letters regarding these plans until final regulations were issued regarding them.

Then, as part of the Pension Protection Act of 2006, Congress provided (prospectively at least) that cash balance plans will not be considered to discriminate on the basis of age if certain requirements are met. As a result of these provisions in the PPA, the Service has lifted its moratorium and is beginning to process determination letters regarding cash balance plans.

However, a plan will not be reviewed regarding whether it discriminates on the basis of age if it was converted to a cash balance plan before June 30, 2005.

Under the new rules in the PPA, a plan does not illegally discriminate on the basis of age if the accumulated benefit of an individual would be greater than a similarly situated younger individual who was also a participant. According to the Service, a participant’s accumulated benefit may be expressed as an annuity payable at normal retirement age, the balance of a hypothetical account or the current value of the accumulated percentage of the employee’s final average compensation.

The PPA also requires that the interest credited to a cash balance plan may not exceed a market rate of return. In the notice, the Service says that guidance will be issued later in 2007 regarding the market rate of return rules.

Pending this further guidance, the Service has provided a safe harbor for what constitutes a market rate of return. According to the safe harbor, a market rate of return includes the rate of interest on long-term investment grade corporate bonds, the rate of interest on 30-year Treasury securities, or the sum of any of the standard indices and the associated margin described in Notice 96-8, 1996-1 C.B. 359.

The Notice is 2007-6, published in Internal Revenue Bulletin 2007-3 at page 272.


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