IRS SECURE 2.0 “Grab Bag” Guidance – Cash Balance Plans
This is the second article on the recent IRS “Grab Bag” guidance on provisions of SECURE 2.0 (Notice 2024-02). Let’s dive into the guidance on SECURE 2.0’s cash balance provision.
To start with the bottom line: The Grab Bag guidance will generally allow plans that have not provided market rate interest credits (e.g., returns on an S&P 500 Index fund) because of IRS anti-backloading rules, to convert to a market rate prospectively without special grandfather rules.
Prior to the change made by SECURE 2.0, the IRS took the position that cash balance plans that provided for a variable interest crediting rate (e.g., a rate based on returns on an S&P 500 Index fund) had to assume that all future interest credits were zero for any year in which the variable rate was negative.
This position created a problem for plans that provided for increasing pay credits, e.g., a formula that provided a pay credit of 3% for the first 5 years of service, 4% for years 6-15, and 5% for years 16 and up. Those plans generally depend on the value of future interest credits to avoid violating ERISA/IRC anti-backloading rules, and because of the IRS’s “future interest credits = 0” rule, generally did not adopt a market interest crediting rate. Instead, they adopted a fixed interest crediting rate (e.g., 4%) or one of the “fixed income index + minimum” rates permitted under applicable regulations (e.g., a 1-year Treasury Rate with a 3% cumulative minimum).
SECURE 2.0 reversed the IRS’s somewhat counter-intuitive position, providing that plans using a variable interest crediting rate could use a reasonable assumption as to the rate of return on, e.g., a designated S&P 500 Index fund or the yield on designated fixed income securities, not to exceed 6%.
In implementing this provision, a critical question has been, if a plan that did not use a market rate (because of IRS’s regulatory position) could it – under the new SECURE 2.0 rule – simply switch (prospectively) to a market rate, or would it be required, under IRC Section 411 anti-cutback rules, to preserve the old fixed (or variable + a minimum) rate for prior accruals?
Clarity about what the SECURE 2.0 change does
Notice 2024-02 begins by making explicit what the SECURE 2.0 fix does. It is worth quoting the IRS at length here:
For a cash balance plan that provides for pay credits to participants that increase with a participant’s age or service and provides for a variable interest crediting rate, the effect of the enactment of [the cash balance provisions] of the SECURE 2.0 Act is that the plan no longer risks violating [IRC anti-backloading rules] if that interest crediting rate falls below a certain point. To prevent such a violation prior to the enactment of [SECURE 2.0], a plan of this type had to provide for a fixed annual minimum interest crediting rate as part of its interest crediting rate. With the enactment of [SECURE 2.0], the fixed annual minimum interest crediting rate is no longer needed.
Generally, no anti-cutback problem for plans switching to a market rate/variable rate
Under Notice 2024-02, plans that either (1) are currently providing increasing pay credits or (2) are being changed to provide for increasing pay credits may do so prospectively, so long as they do not reduce a participant’s “accumulated benefit” (that is, the balance in the participant’s cash balance account) “determined as of the end of the interest crediting period that includes the applicable amendment date.” In other words, plans cannot take away interest credits that have already accrued.
The IRS further clarifies SECURE 2.0 anti-cutback relief for cash balance plan amendments as follows:
- The relief “applies with respect to an amendment that affects interest credits for interest crediting periods beginning after the later of the effective date of the amendment or the date the amendment is adopted, but not interest credits for interest crediting periods beginning before the later of the effective date of the amendment or the date the amendment is adopted.”
- The relief applies “only if: (1) the plan’s interest crediting rate prior to the amendment is the greater of a fixed annual minimum rate or [a fixed income index + minimum permitted under regulations], and the amendment either (a) reduces or eliminates the fixed minimum interest crediting rate while retaining the underlying interest rate … or (b) changes the interest crediting rate to an investment-based rate [i.e., a market rate interest crediting rate]; or (2) the plan’s interest crediting rate prior to the amendment is a permitted fixed rate …, and the amendment changes the interest crediting rate to any permitted variable rate ….”
We note that these rules are (obviously) very technical and can only be summarized here. They do, however, allow sponsors of plans with increasing pay credits significant flexibility in converting to market-based interest credits. Those sponsors should consult with their legal and actuarial advisors as to how best to go about doing so.
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Reprinted with permission of O3 Plan Advisory Services.