The Pension Protection Act of 2006 ("PPA") provided extensive new rules to deal with many issues that have proved problematic for cash balance and pension equity plans. Among those new rules were special requirements for "applicable defined benefit plans." The new rules for applicable defined benefit plans include specific guidelines regarding interest credits, principal credits, market rate of return, conversions and wearaway (subsets of age discrimination), and plan termination.
Section 411(b)(5)(B) of the Internal Revenue Code bears the caption Applicable Defined Benefit Plans," thus referring to what the statute describes as "a defined benefit plan under which the accrued benefit (or any portion thereof) is calculated as the balance of a hypothetical account maintained for the participant or as an accumulated percentage of the participant's final average compensation." Subparagraph (B) imposes several requirements on such plans that cannot, or do not choose to, utilize the safe harbor rule, as a condition of satisfying Section 411(b)(1)(H). Any such plan will be treated as failing to meet the anti-age discrimination requirements of that section if it does not observe all of these new statutory requirements.
 Interest Credits
The terms of the plan must not provide for an interest credit (or equivalent amount) for any plan year at a rate greater than a market rate of return. This requirement is not failed merely because the plan provides for a reasonable minimum guaranteed rate of return or for a rate of return that equals the greater of a fixed or variable ROR. The statute does not further define a "market rate of return," leaving it to Treasury to provide by regulation for its calculation and for permissible methods of crediting interest (including fixed or variable rates) meeting the above requirements. Prior to issuing proposed regulations in December 2007, the Service announced in its initial guidance, Notice 2007-6, that a market rate of return includes the rate of interest on long-term investment-grade corporate bonds prior to amendment by the PPA '06 for plan years beginning before January 1, 2008, and the so-called "third segment rate" described in IRC Section 430(h)(2)(C)(iii) for subsequent plan years. The Notice also references other permissible indices to which a market return can be pegged.An additional requirement relating to interest credits, which the statute labels a "preservation of capital," directs that an interest credit of less than zero shall in no event result in a hypothetical account balance of less than the aggregate amount of contributions credited to the account...
 Principal Credits
A principal credit means any increase to a participant's accumulated benefit that is not an interest credit, and so includes an increase conditioned on current service or made on account of imputed service. [Treas. Reg. § 1.411(b)(5)-1(d)(1)(iv)(D).]
 Market Rate of Return
... [T]he 2010 Final Regulations provide that an interest crediting rate is not in excess of a market rate of return if it can never be in excess of a particular rate that meets the market rate of return limitation. [Treas. Reg. § 1.411(b)(5)-1(d)(1)(v).]
An interest crediting rate for a plan year is not in excess of a market rate of return if it is based on the rate of interest provided under any one of several specified indices. The 2010 Final Regulations expand the list of safe-harbor rates. [Treas. Reg. § 1.411(b)(5)-1(d)(1)(iii), (d)(3), (d)(4).]
The 2010 Final Regulations also set forth certain interest crediting rates that satisfy the market rate of return requirement but that are not safe harbor rates. [Treas. Reg. § 1.411(b)(5)-1(d)(1)(v).] The 2010 Proposed Regulations would provide that certain additional interest crediting rates satisfy the market rate of return limitation.The 2010 Proposed Regulations would (i) provide that a plan does not fail to meet the interest crediting requirements merely because the plan does not provide for interest credits on amounts distributed prior to the end of the interest crediting period, and (ii) allow plans to credit interest by taking into account increases or decreases to the participant's accumulated benefit that occur during the period. [Prop. Treas. Reg. § 1.411(b)(5)-1(d)(1)(iv)(D).]...
 Conversions and Wearaway
Section 411(b)(5)(B)(ii)-(iv) imposes minimum benefit requirements on the conversion of a traditional defined benefit plan to an "applicable" defined benefit plan (see introductory paragraph of this paragraph [b] above), which are designed to eliminate the wearaway problem. The plan is deemed to fail the anti-age discrimination rule if the so-called A-plus-B design is not used, under which the accrued benefit of each participant after the conversion amendment, who was a participant in the plan immediately before the adoption of the conversion amendment, shall not be less than the sum of-(A) the participant's accrued benefit for years of service before the effective date of the conversion amendment, determined under the terms of the plan as in effect before the amendment, and(B) the participant's accrued benefit for years of service after the effective date of the amendment, determined under the plan terms as in effect after the amendment.The regulations suggest that participants' benefits must conform with the A-plus-B requirement "at any subsequent annuity starting date." [Treas. Reg. § 1.411(b)(5)-1(c)(2)(i).]...
The 2010 Final Regulations provide rules regarding when a non-hybrid plan will be deemed to be amended to become a hybrid plan. Such amendments are referred to as "conversion amendments." An amendment will be deemed to be a conversion amendment if (i) the amendment has the effect of reducing or eliminating benefits that, but for the amendment, the participant would have accrued after the amendment effective date under a non-hybrid benefit formula and (ii) after the amendment, all or a portion of the participant's benefit accruals are determined under a hybrid benefit formula. [Treas. Reg. § 1.411(b)(5)-1(c)(4).] Only amendments that reduce or eliminate accrued benefits described in Code Section 411(a)(7), or retirement-type subsidies described in Code Section 411(d)(6), that would have otherwise accrued as the result of future service will be treated as conversion amendments. A conversion amendment will be deemed to be effective on the date on which the participant's future benefit accruals under a non-hybrid benefit formula are reduced or eliminated.
Presumably, the added provision in the statute, carrying the caption "Special Rules For Early Retirement Subsidies," providing for recognition of the retirement subsidy when the participant retires, was meant to deal with that problem. The regulations do not appear to address this. Paragraph (c) of Regulation Section 1.411(b)(5)-1 provides extensive requirements for satisfying the statute's special rules for plan conversion amendments, with densely fact-intensive examples, that do not seem to deal with the matter. It would be helpful if further guidance were to clear up the matter.
 Plan Termination Requirements
Under Section 411(b)(5)(B)(vi) an applicable defined benefit plan will not be treated as meeting the requirements relating to interest credits described in section  above unless the plan provides that, upon termination of the plan, first, if the interest credit rate under the plan is a variable rate, accrued benefits under the plan will be calculated using a five-year average interest rate, and, second, the interest rate and mortality table to be used for determining any benefit payable as an annuity commencing at normal retirement age shall be specified under the plan. Note that the statute is dealing here only with plan terminations...
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RELATED LINKS: For additional information and insight, see:
Lexis Tax Advisor -- Federal Code Explanations § 411(a) - General Rule
Lexis Tax Advisor -- Federal Code Explanations § 411(b) - Accrued Benefit Requirements
Lexis Tax Advisor -- Federal Code Explanations § 411(d) - Special Rule
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