On September 18, 2014, the Internal Revenue Service (IRS) released proposed (26 C.F.R. § 1.411(b)(5)–1) and final (26 C.F.R. § 1.411(a)(13)–1) regulations relating to hybrid retirement plans, such as cash balance plans and pension equity plans. The final regulations provide guidance on certain issues under IRC Sections 411(a)(13) and 411(b)(5) that were not addressed in the 2010 final regulations and make other changes to those sections. The proposed regulations issued in connection with the final regulations provide anti-cutback relief under IRC Section 411(d)(6) so that plans may be amended to comply with the guidance without violating the anti-cutback rules.

Hybrid defined benefit plans, such as cash balance plans or pension equity plans (PEP), combine features of both defined contribution and defined benefit plans. In a hybrid plan, the participant's accumulated benefit is usually expressed as:

(see Practice Note, Requirements for Qualified Retirement Plans: Hybrid Plans.)

There have been many controversial issues regarding hybrid plans, including whether:

The Pension Protection Act of 2006 (PPA) addressed many of these issues by:

In 2010, the IRS issued proposed (75 FR 64197) and final (75 FR 64123) regulations for hybrid plans implementing the changes made to hybrid plans under the PPA. The 2010 proposed regulations provided a list of permissible interest crediting rates that satisfy the market rate of return requirement to include:

(See Practice Note, Cash Balance Plans: Market Rate of Return Rules.)

On September 18, 2014, the IRS issued additional final regulations to provide guidance on certain issues that were not addressed in the 2010 final regulations and make other changes to those sections. These rules are generally effective for plan years that begin on or after January 1, 2016 and provide guidance on:

The final regulations also permit defined benefit plans that adjust benefits using a variable rate that could be negative under the 133 1/3% rule to apply this rule earlier than permitted in the 2010 proposed regulations.

The proposed regulations provide transition relief from the anti-cutback rule for plans that use an interest crediting rate that is not permitted under the final regulations. A plan may be amended to change to an interest crediting rate that is permitted before the first day of the first plan year that begins on or after January 1, 2016. (Normally an amendment that reduces the interest crediting rate for benefits that have accrued would be an impermissible cutback that would violate IRC Section 411(d)(6) (see Practice Note, Protected Benefits under IRC Section 411(d)(6)).)

To obtain IRC Section 411(d)(6) relief under the proposed regulations, the amendment must be adopted before and effective no later than the first day of the first plan year that begins on or after January 1, 2016. The amended rate will apply to previously accrued benefits, but only for interest credits for periods after the amendment is adopted, or if later, for periods after the amendment is effective.

Comments on the proposed regulations are due by December 18, 2014. IRS representatives at a recent American Bar Association Section of Taxation meeting indicated that a hearing is scheduled on these proposed regulations in January of 2015 and they anticipate final regulations being issued in the early part of 2015.

The proposed and final regulations provide some long anticipated guidance by addressing prior concerns from practitioners, including, raising the variable interest rate floor and permitting the crediting of interest rates equal to a subset of plan assets (if certain requirements are met). Plan sponsors may need to make meaningful changes to their plans but have some time for implementation since the IRS provided a January 1, 2016 effective date. Plans sponsors should review the implications of the guidance with their actuaries to determine whether action is needed.