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  2. REGULATION AND LEGISLATION
September 29, 2014 01:00 AM

Guidance, flexibility offered in cash balance rules

Hazel Bradford
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    Judy Miller called the more predictable cost of cash balance plans a major advantage.

    Cash balance plan sponsors got a compliance road map and added flexibility in picking expected rates of return when final regulations on the hybrid plans were issued by the Treasury Department and Internal Revenue Service.

    The regulations, adopted Sept. 18, “make possible a type of retirement plan our country sorely needs,” said Richard Shea, a Washington attorney with law firm Covington and Burling, who chairs the employee benefits and executive compensation practice. Cash balance plans can provide “all the cost-efficient lifetime income options and survivor protections afforded by a defined benefit plan, while permitting employees to earn market rates of return that adjust over time to their shifting tolerances for risk — key elements in any rational retirement design.”

    Cash balance plans have the benefit defined as an account balance, not an annuity, and adjust benefits to reflect investment performance. Employers put in pay credits, which are typically expressed as a percentage of pay, while earnings credits (or interest credits) are based on investment returns. That leaves some investment risk on employees. But unlike defined contribution plans, asset allocation decisions are made by professionals, and principal capital is preserved. The plans are also covered by the Employee Retirement Income Security Act, which includes Pension Benefit Guaranty Corp. protection.

    Cash balance and other hybrid defined benefit plans were seen as a promising way to preserve defined benefit plans in 2006 when Congress passed the Pension Protection Act, which called for the guidelines. That enthusiasm waned when it took four years for guidelines to be proposed, and another four years for them to be finalized. Lawsuits alleging age discrimination didn't help, either.

    The new rules, which also address vesting, age discrimination and conversions, apply to plan years beginning on or after Jan. 1, 2016. The IRS and Treasury Department also proposed additional regulations to help executives determine how to properly amend cash balance plans that don't conform to the new rates without running afoul of rules against benefit cutbacks. Comments on those proposed changes are due in December.

    Key features of the final rules allow sponsors to use higher rates of return for cash balance plans instead of more conservative safe-harbor rates being used now and increase the maximum permitted fixed-interest credit to 6% from 5%.

    “That's a huge change,” said Judy Miller, director of retirement policy for the American Society of Pension Professionals & Actuaries, Arlington, Va. “Using the plan's rate of return as the interest rate means that investment risk really doesn't have to be placed on the employer” because contributions are based on actual returns.

    Instead of crediting years of service like a traditional defined benefit plan, cash balance plans use an interest crediting rate. Matching the crediting rate to market rates of return makes it easier for sponsors to plan how much money to set aside, because liabilities are aligned with plan assets. It also makes corporate balance sheets much less volatile than with traditional defined benefit plans, in which an employer's contribution is subject to market returns and interest rates. “More predictable cost is one of the main attractions,” Ms. Miller said.

    In August, Eastman Kodak Co., Rochester, N.Y., announced it would move all of its U.S. employees to a cash balance plan effective Jan. 1, a move company officials expect will reduce future benefit obligations by about $55 million and costs by $12 million each year.

    Capping the credit at 6% should make some current cash balance plans that offer higher rates less expensive and could entice other employers to consider them, now that there is a ceiling on how much sponsors can contribute.

    “It's a combination of what you can afford and what you want to provide,” said Alan Glickstein, senior retirement consultant at Towers Watson & Co. in Dallas.

    Another big change was allowing plans to credit different rates of return for subsets of plan assets. That's important, said Covington & Burling partner Robert Newman, because it allows a plan “even to credit different rates for different groups of participants based on different subaccounts” to address different workforce goals.

    “Employers like that flexibility,” said Kathryn Ricard, senior vice president for retirement policy at the ERISA Industry Committee in Washington. “As a group moves through its work cycle or an employer changes what it does, you need to have the tools to change with that.”

    Daniel Kravitz, president of cash balance plan management firm Kravitz Inc. in Los Angeles, expects that sponsors will still make conservative investment choices, “but I'm seeing a lot more opportunity for people to get creative with investment strategies. The regulations do make it clear that investment choices are up to the employer.”

    The clarity provided in final rules “is almost as important as the number” provided by the rate guidance,” said Mr. Glickstein. “Now (sponsors) have a much clearer picture about how to do (cash balance plans). It may be a much more viable option.”

    Unlike the continued decline in traditional defined benefit plans, the number of companies offering cash balance and other hybrid plans is holding steady, according to Towers Watson. At the end of both 2012 and 2013, 84 of the Fortune 500 companies offered them.

    If final rules had been in place earlier, “many more companies would have gone down this path. The data suggest that there was a lot of interest,” said Mr. Glickstein. A prime candidate, he said, is a rapidly growing high-tech company that has matured and wants to retain employees who lost faith in their 401(k) plans after being dinged by the recession.

    For smaller employers, there has been substantial growth. A 2014 national cash balance study by Kravitz showed a 22% increase. The analysis of IRS data showed 9,648 cash balance plans with $858 billion in assets as of 2012. Of those, 87% are sponsored by companies with fewer than 100 employees.

    Kravitz also found the average employer contributions in companies with both 401(k) and cash balance plans was 6.3% of pay, compared to an average of 2.6% of pay for firms just offering a 401(k).

    Having final rules “will only have a positive impact on the future growth rate,” said Mr. Kravitz. “There are cost savings to large organizations, but what we're seeing is (interest from) small and midsize companies as a means to enhance DC plans.” n

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