IRS finalizes cash balance regulations, adds more flexibility for ReDB designs

On September 19, 2014, IRS published long-awaited final regulations on permissible interest crediting rates in cash balance plans.

The new regulations are very good news. They confirm IRS’s proposed rules establishing the market-based cash balance design (what we call ReDB®), and they permit significantly increased flexibility in cash balance plan design.

We’ve provided a detailed discussion of the new rules in our related article. Here are the headlines –

Confirmation of ReDB® plan design: In its proposed rules IRS said that sponsors could, beginning in 2010, adopt what we call a ReDB® plan design – a cash balance plan using an interest crediting rate that reflects actual investment returns. This design allows DB plans to provide transparent benefits and stable costs – features previously available only in DC plans. The new regulations finalize those rules.

Some sponsors were uncomfortable with a design that was only authorized by proposed regulations (even with provision for ‘reliance’). Now, the clear message of the Pension Protection Act is supported by clear regulations.

This is great news, because we believe this design – ReDB® – is the retirement plan of the future. For sponsors who have been holding back, now is the time to consider how this design can improve participant satisfaction and address sponsor concerns about DB risk and DC shortcomings.

But that’s not all. The final regulations also provided –

Added flexibility for ReDB® plans: The final regulations add a new rule that allows a cash balance plan to use an interest crediting rate that is equal to the performance on a subset of trust assets. This new rule adds a couple of really important design options for plans that wish to provide interest credits based on actual trust returns. First, these ReDB® plans can now provide something very much like target date funds – that is, different investment styles can be used for different employee groups. For instance, a more conservative investment style could be offered for long service employees, while a less conservative style could be offered for shorter service employees.

Second, this new rule will allow sponsors that base credits off of actual trust returns to uncouple investment decisions for ‘legacy’ benefits (such as current retirees) from investments credited to the accounts of active participants, allowing plans to de-risk retired liability (with, e.g., a bond portfolio) while providing interest credits based on a portfolio more appropriate for active employees.

Added flexibility in bond-based rates, floors and minimums: Finally, IRS increased the fixed rate that can be used (from 5% to 6%) and the annual floor that can be used where the interest crediting rate is based on government bonds (from 4% to 5%), providing welcome relief to many sponsors of ‘traditional’ (non-market based) cash balance plans. For ‘market-based’ (ReDB®) designs, the regulations confirmed the ability to provide a cumulative floor on interest credits of up to 3%.

The list of interest crediting rates approved by IRS is exclusive, and sponsors with “non-conforming interest crediting rates” will have to amend their plans (generally by 2016). But, in connection with the final regulations, IRS proposed rules to ease the transition.

October Three has designed more than 50 ReDB® plans for clients since 2010. We have the -expertise – and the technology, in the form of a live administrative system built expressly for these plans – to bring these designs to life for employers of all descriptions.