November 13, 2015
- IRS Provides Guidance for Transition to Final Hybrid Rules
- Obama Administration Releases Collective Final Regulations on Various ACA Matters
IRS Provides Guidance for Transition to Final Hybrid Rules
The Internal Revenue Service (IRS) issued final transitional amendments governing the “market rate of return” rules for hybrid retirement plans on November 13, giving plan sponsors until 2017 to come into compliance with certain key elements of the previous regulations finalized in 2014.
Hybrid retirement plans, such as cash balance plans and pension equity plans, are defined benefit plans but also contain features that resemble defined contribution plans. In September 2014, the IRS published final regulations addressing market rate of return rules for hybrid plans (i.e., the amount of interest rate credit that can be provided by a plan) under the Pension Protection Act of 2006, along with proposed rules offering transitional guidance for hybrid plans that are not yet in compliance with the final rules (see the September 18, 2014, Benefits Byte). The Council subsequently filed written comments recommending changes to the proposed transition rules.
The transitional amendments, as finalized, generally allow plan amendments to change the interest crediting rate under a hybrid plan from a rate that is not on the list to a rate that is on the approved list of interest crediting rates and combinations of rates. The rules apply to amendments made between September 18, 2014 and the first day of the plan year beginning on or after January 1, 2017.
Most notably, the final regulations released on November 13 delay the applicability date for certain provisions of the 2014 final rules from 2016 until 2017, including those provisions that provide a list of interest crediting rates and combinations of rates that satisfy ERISA’s requirement that the plan not provide an effective rate of return in excess of a market rate of return.
The rules did not address pension equity plan (PEP) matters. The Council’s comment letter urged IRS not to apply rules for PEPs retroactively, through either guidance or enforcement.
The final rules also provide the following technical guidance, focusing largely on the use of investment-based rates versus non-investment-based rates. (An investment-based rate is a rate of return provided by actual investments, taking into account the return attributable to any change in the value of the underlying investments. A rate of return that is based on the rate of return for an index that measures the change in the value of investments can also be considered to be an investment-based rate. Non-investment-based rates are either fixed rates of interest or bond-based rates (such as yields to maturity of bonds).
- Final regulations in many cases permit a plan sponsor to choose between one of two or more alternative amendments in order to bring a plan into compliance on crediting rates.
- Any non-investment based variable rate that does not meet regulatory requirements (including the greater of two or more non-investment based variable rates) may be capped at the third segment interest rate. However, the third segment rate would also apply as a limitation on any annual fixed minimum rate that is part of the composite rate. The third segment rate is an interest rate, provided by the IRS, used in determining plan liabilities and is based on benefits payable after 20 years (a long-term rate).
- If a plan uses an investment-based rate and there is no permitted investment-based rate with similar risk and return characteristics, the plan can either switch to an approved investment-based rate that is less volatile or switch to the third segment rate with a fixed 4 percent minimum rate.
- Plans using an investment-based rate with an impermissible annual (or more frequent) fixed or variable rate minimum can either (1) eliminate the fixed minimum rate (or any variable non-investment based rate minimum) and eliminate any reduction to the investment-based rate, or (2) switch to the third segment rate (preserving any fixed minimum rate to the extent permitted).
- If a plan has a cumulative floor (possibly caused by a change in crediting rates under a prior amendment) or a “greater-of” formula, a special rule requires an amendment that each participant’s benefit is based on the greatest benefit as of the amendment date (but the rates must satisfy other rules in the regulations).
- The regulation includes a new rounding rule (annual rate to the nearest 25 basis points) and provides anti-cutback relief for transitional amendments.
- Treasury and the IRS continue to study plans that permit participants to choose among a menu of hypothetical investment options and could make further change in the future (or even disallow these participant-directed arrangements). In the meantime, plan sponsors can use the regulatory guidance to individually fix any impermissible choice or totally eliminate the entire choice.
Obama Administration Releases Collective Final Regulations on Various ACA Matters
Late on November 13, the U.S. Departments of Treasury, Labor (DOL) and Health and Human Services (HHS) released a package of final regulations related to the Affordable Care Act (ACA), formally codifying rules that had been, until now, issued in “interim final” form.
These rules address:
- Grandfathered plans
- Preexisting condition exclusions
- Lifetime and annual limits
- Dependent coverage
- Patient protections
The Council is reviewing these final rules and will report on any items of note for employer plan sponsors. For more information, contact Kathryn Wilber, senior counsel, health policy, at (202) 289-6700.