By Mark M. Brown, Lori L. Shannon and Ryan C. Tzeng
The deadline for amending hybrid defined benefit plans to comply with recent changes in applicable law is the last day of the 2015 plan year – December 31, 2015, for calendar year plans. The IRS issued final regulations on September 19, 2014, that contain clarifications regarding certain issues applicable to these plans. Sponsors of defined benefit plans should determine whether their plans are subject to the regulations and, if so, should make sure that any required amendments are made by the deadline.
Is Your Defined Benefit Plan Subject to the Regulations? Defined benefit plans are subject to the hybrid plan rules if benefits are determined under a “lump sum-based formula” (i.e., a formula in which the benefit is expressed as a hypothetical account balance or an accumulated percentage of final average compensation) or a formula that has a similar effect to a lump sum-based formula. The most common type of hybrid plan is a cash balance plan; other types include pension equity plans (PEP) and plans with variable annuity benefits. A plan with a hybrid formula may be subject to the regulations even if no benefits are currently accruing (a frozen plan).
If your defined benefit plan is subject to the hybrid plan rules, you should make sure that the plan is amended as necessary to satisfy the following requirements:
Age Discrimination. Generally, a participant’s accumulated benefit cannot be less than that of a similarly situated younger participant. Age discrimination can be determined on the basis of an annuity payable at normal retirement age, the balance of a hypothetical account, or the value of an accumulated percentage of final average compensation. Special rules apply if a plan uses a combination of formulas (such as the greater or lesser of two formulas).
Market Rate of Return. The interest crediting rate under a hybrid plan cannot exceed a market rate of return. The final regulations include an exclusive list of the rates or types of rates that satisfy this requirement, as well as rules regarding the time and manner of interest credits. If the plan’s current interest crediting rate exceeds a market rate of return, the rate must be revised prospectively.
Preservation of Capital Requirement. Except in the case of certain variable benefits, a hybrid plan must provide that a participant’s benefit cannot decrease to less than the sum of all principal credits made on behalf of the participant (in other words, interest credits under the plan cannot result in a net loss). Special rules apply in the case of multiple annuity starting dates.
Vesting. A hybrid plan must provide full vesting after three years of service with respect to a participant’s entire benefit if any part of the benefit is determined under a hybrid formula.
Plan Termination Rules. A hybrid plan must include special rules for determining interest credits and actuarial adjustments after a plan termination.
Actuarial Increases after Normal Retirement Age. Benefits that commence after normal retirement age must be actuarially adjusted for late commencement unless the suspension of benefit rules are satisfied. If interest credits are insufficient to satisfy this requirement, an additional adjustment to a participant’s benefit must be provided.
Conversion Requirements. Special requirements apply to certain amendments under which a defined benefit plan is converted from a nonhybrid formula (e.g., a traditional defined benefit formula) to a hybrid formula. In general, a conversion has occurred if benefits under a nonhybrid formula are reduced or eliminated on or after June 29, 2005, and a hybrid formula is adopted at the same time or at a later time. After a conversion, a participant’s benefit cannot be less than the sum of (i) the benefit with respect to service before the conversion, determined under the terms of the plan as in effect before the conversion, plus (ii) the benefit with respect to service after the conversion, determined under the terms of the plan in effect after the conversion.
Drinker Biddle Note: This is a summary intended to provide an overview of the key required provisions applicable to hybrid defined benefit plans. Plan sponsors who have questions regarding whether their plans must be amended to be compliant with the hybrid defined benefit plan regulations should consult counsel.