Considerations for Changing the Interest Crediting Rate in a Cash Balance Plan

Cash balance plans base benefits on a hypothetical account balance, increased with principal credits, and adjusted with interest credits. Interest credits cannot exceed a market rate of return.

 

In an issue snapshot, the Internal Revenue Service (IRS) discusses the when a plan amendment reduces (or potentially reduces) the interest crediting rate. The agency first explains that Internal Revenue Code (IRC) Section 411(d)(6) provides that an accrued benefit may not be decreased by amendment, and IRC Section 411(b)(5)(B)(i) provides that an applicable defined benefit plan fails the requirements of IRC Section 411(b)(1)(H) if the plan provides interest credits that exceed a market rate of return.

 

If the terms of a statutory hybrid plan entitle the participant to future interest credits, a plan must comply with IRC Section 411(d)(6) by protecting the old interest crediting rate for the accrued benefit if (1) the plan is amended to change the interest crediting rate, and (2) under any circumstances the revised rate could result in interest credits that are smaller than the interest credits that would be provided without regard to the amendment.

 

There are two methods commonly used to satisfy IRC Section 411(d)(6) when a cash balance plan is amended to change the interest crediting rate: the “A plus B approach” and “wearaway.”

 

According to the issue snapshot, under the A plus B approach, plan sponsors must keep up with two separate hypothetical accounts. The “A” account is the original account which continues to accumulate interest credits at the old interest crediting rates, with no additional principal credits. The “B” account is a new account with an opening balance of zero. Future principal credits are credited to this account, and interest credits are credited at the new interest crediting rate. The participant’s benefit is based on the sum of the “A” account and the “B” account.

 

Under the wearaway method, the account balance is the greater of:

• The hypothetical account balance at date of change, increased with interest credits at the old interest crediting rate; or
• The hypothetical account balance at the date of change, increased with principal credits and interest credits at the new interest crediting rate.

 

Treasury Regulation Section 1.411(b)(5)-1(e)(3)(iii) provides a special market rate of return rule allowing the wearaway method to be used for participants who were still earning pay credits as of the date the interest crediting rate was changed, even if the combination of the old and new interest rates would otherwise violate the market rate of return rules. The IRS notes that this special rule does not apply to participants who were no longer earning principal credits as of the date the interest crediting rate was changed.

 

The issue snapshot provides examples of both the “A plus B” and “wearaway” approaches and provides examples assuming that the participant has terminated at the date of change of the interest crediting rate or is otherwise not earning any principal credits. It also notes that some plan sponsors may have terminated their plans in order to reduce their ongoing interest credits. The plan sponsors who take this approach are hoping to terminate the current plan and establish a new plan with a different interest crediting rate, and therefore avoid the need to protect the old interest crediting rate on participants’ accrued hypothetical account balances.