The IRS issued final and 2010 proposed regulations for hybrid defined benefit (DB) plans – DB plans that express participants' accumulated benefits as a lump sum. In general, the final regulations: incorporate the transitional guidance in Notice 2007-6 and the 2007 proposed regulations, and provide guidance on Internal Revenue Code Sections 411(a)(13) and (b)(5). The 2010 proposed regulations provide additional guidance for hybrid DB plans that compute accrued benefits by reference to a hypothetical account balance or equivalent amounts (under Code Section 411(a)(13)) and discuss a hybrid DB plan's accrued benefit requirements (under Code Sections 411(b)(1) and (b)(5)). The Final Regulations address items including: Definitions - that apply to regulations under Code Sections 411(a)(13) and (b)(5). Accumulated benefit - a participant's benefit accrued to date under a plan. Lump sum-based benefit formula - a benefit formula under which all or some of the accumulated benefit is expressed as the current balance of a hypothetical account or as the current value of the accumulated percentage of the participant's final average compensation. Statutory hybrid benefit formula - a benefit formula that is either a lump sum-based benefit formula or a formula that has an effect similar to a lump sum-based benefit formula. Effect similar to - a benefit formula has an effect similar to a lump sum-based benefit formula if: the formula providing a participant's accumulated benefit at normal retirement age includes adjustments for a future period; and the total dollar amount of the adjustments is reasonably expected to be smaller for the participant, when compared to a similarly situated, younger individual who is or could be a participant in the plan. Hypothetical account - a benefit is expressed as a hypothetical account if it is expressed as a current single sum dollar amount whether or not the participant has the right to future interest credits. Statutory hybrid plan - a plan that contains a statutory hybrid benefit formula. Pension equity plans (PEPs) - a PEP formula that provides for interest credits after PEP accruals stop must follow the market rate of return rules to calculate interest credits because a lump sum-based benefit formula that credits interest is subject to the market rate of return rules. After-tax and rollover contributions - the benefit properly attributable to after-tax employee contributions, rollover contributions and other similar employee contributions is disregarded in determining if a benefit formula is a lump sum-based benefit formula. Indexing of benefits - when determining whether a benefit formula has an effect similar to a lump sum-based benefit formula, certain indexing to adjust benefits after the annuity starting date (for example, cost-of-living increases) is disregarded. Adjustments under a variable annuity - do not have an effect similar to a lump sum-based benefit formula if the assumed interest rate used to determine the adjustments is 5% or higher. Special Rules under Code Section 411(a)(13)(A) - a plan will not be treated as failing the requirements of Code §411(a)(2) or the accrued benefit derived from employer contributions requirements of: Code Section 411(a)(11), Code Section 411(c), or Code Section 417(e) just because a statutory hybrid plan provides that the present value of benefits determined under a lump sum formula is equal to the then-current balance of the hypothetical account maintained for the participant or the then-current value of the accumulated percentage of the participant's final average compensation under that formula. However, it is important to note that Code Section 411(a)(13) does not change the definition of the accrued benefit under Code Section 411(a)(7)(A) or the definition of the normal retirement benefit under Code Section 411(a)(9). Present value rules of Code Section 417(e) - a statutory hybrid plan that provides benefits under a benefit formula that is a statutory hybrid benefit formula other than a lump sum-based benefit formula must comply with the present value rules of Code Section 417(e) for an optional form of benefit that is subject to the requirements of Code Section 417(e). Vesting - a plan fails to satisfy the requirements of Code Section 411(a)(2) if any part of a participant's DB accrued benefit is determined under a statutory hybrid benefit formula unless the plan states: a participant with 3 or more years of service has a non-forfeitable right to 100% of the participant's accrued benefit from employer contributions. This requirement applies to the participant's entire benefit from employer contributions under a statutory hybrid plan (not just the portion of the participant's benefit that is determined under a statutory hybrid benefit formula); and the 3-year vesting requirement applies to the participant's entire accrued benefit under the plan if a participant is entitled to the greater of two (or more) benefit amounts, where each amount is determined under a different benefit formula, and at least one of which is a benefit calculated under a statutory hybrid benefit formula (even if that participant's benefit under the statutory hybrid benefit formula is ultimately smaller than under the other formula.) Safe-harbor for age discrimination - a plan may satisfy the requirements of Code Section 411(b)(1)(H)(i) with respect to certain benefit formulas if, as determined as of any date, a participant's accumulated benefit expressed under one of those formulas would not be less than any similarly situated, younger participant's accumulated benefit expressed under the same formula. Conversion protection - a participant whose benefits are affected by a conversion amendment that was both adopted and effective on or after June 29, 2005, must generally be given a benefit after the conversion that is at least equal to the sum of the benefits: accrued through the date of the conversion, and earned after the conversion, with no allowed interaction between these two portions. Conversion amendment - an amendment, determined on a participant-by-participant basis (including multiple amendments) is a conversion amendment if: it reduces or eliminates the benefits that, except for the amendment, the participant would have accrued after the effective date of the amendment under a benefit formula that is not a statutory hybrid benefit formula and under which the participant was accruing benefits before the amendment; and after the effective date of the amendment, all or a portion of the participant's benefit accruals under the plan are determined under a statutory hybrid benefit formula. Interest credit - generally means any increase or decrease for a period to a participant's accumulated benefit, including under a statutory hybrid benefit formula, which is calculated under the terms of the plan at the beginning of the period by applying a rate of interest or rate of return (including a rate of increase or decrease under an index) to any portion of the participant's accumulated benefit as of the beginning of the period that: is not conditioned on current service; and is not made because of imputed service. Market rate of return - an interest crediting rate does not exceed a market rate of return if: it is always less than a particular interest crediting rate that meets the market rate of return limitation; or it always equals the lesser of two or more rates when at least one of the rates meets the market rate of return limitation. Safe-harbor interest crediting rate - the list of safe-harbor rates has been increased to include the first and second segment rates. Indexed benefits - for Code Section 411(b)(5)(E) indexed benefits, an interest crediting rate equal to the actual rate of return on the plan's aggregate assets, both positive and negative, is not greater than a market rate of return if the plan's assets are varied to reduce the volatility of returns. Protected Benefit - the right to future interest credits not based on future service is a protected benefit under Code Section 411(d)(6). The 2010 Proposed Regulations address issues, including: Code Section 411(a)(13)(A) relief - does not apply to benefits determined under a lump sum-based benefit formula unless certain conditions are met. However, the relief: extends to an optional form of benefit currently payable under a lump sum-based benefit formula under certain circumstances; and applies on a equal basis to a payment of part of the benefit under a lump sum-based benefit formula not paid in the form of an annuity. 133⅓% Rule - a plan that determines any part of the participant's accrued benefit based on a statutory hybrid benefit formula using a variable interest crediting rate that was less than zero for the prior plan year would not fail the requirements of the 133⅓% rule for the current plan year just because the variable rate is assumed to be zero for the current plan year and all future plan years. Alternative method of satisfying conversion protection requirements - certain plans may meet the conversion protection requirements of Code Sections 411(b)(5)(B)(ii) through (iv) by setting up an opening hypothetical account balance without a later comparison of benefits at the annuity starting date. Preservation of capital requirement - applied only at an annuity starting date when the distribution of the participant's entire benefit as of that date under the plan's statutory hybrid benefit formula starts. Rate of return on plan assets as a market rate of return - generally allowed if the plan assets are diversified in order reduce the volatility of returns. Market rate of return - the proposed regulations expand the list of safe-harbor interest crediting rates. They also provide the following guidance: an interest crediting rate does not exceed a market rate of return if it is equal to the rate of return for certain registered investment companies; a 3% floor that applies on a cumulative basis may be combined with any allowable rate; a plan may use an annual floor of 4% with an allowable bond rate; a fixed annual interest crediting rate of 5% is a safe harbor rate and is deemed not to exceed the rate of interest on long-term investment grade corporate bonds; terminating plans must use interest crediting rates and annuity conversion factors (the interest rate and mortality table used) as set out in the regulations; and interest crediting rate changes and Code Section 411(d)(6) protected benefits rules.
