Hybrid plan transition rules would not mandate that prior plan designs be treated as improper, Treasury officials say

Final and proposed regulations on hybrid pension plans do not require that prior plan designs be treated as improper, according to Treasury Benefits Tax Counsel George Bostick, in remarks to the American Bar Association’s Joint Committee on Employee Benefits made in November 2014.

Bostick said that the Treasury and the IRS do not expect people to read the government’s mind. The setting of permitted interest rates in the final regulations does not imply that certain rates used in the past would fail, he added. The new rules should have no influence on whether a past rate is acceptable. Harlan Weller, Treasury actuary, agreed. Plans should not be discomforted by the rates in the final regulations. On the other hand, the government cannot say that everything used in the past is acceptable, Bostick commented.

Between the statutory effective date of 2008 for hybrid plans, and the effective date of the regulations (2014 or later), there is a long period where the rules are unclear, said Richard Shea, Covington and Burling LLP, who moderated the program. Kathryn Ricard of the ERISA Industry Committee said that her group provided substantial comments on this issue and is very sensitive to gap issues, particularly for people who have determination letters.

The proposed regulations would provide transition rules for plans to move from a “bad” interest rate to a permitted rate, Shea said. Weller emphasized that there is no reliance on the proposed regulations. People can develop plan transitions based on the proposed regulations, but he would not recommend that plan amendments be adopted until final regulations are issued. Moreover, plans can expect to have until the end of 2015 to adopt transition amendments, Weller said.

The new regulations are important because they provide an opportunity for changing the design of hybrid plans, substantially reduce volatility for plan sponsors and provide more retirement security for participants than defined contribution plans (such as participant-directed 401(k) plans), Shea said. The “guts” of the regulations address permissible or market rates of return, according to Shea. The regulations provide an “exclusive list” of market rates, including interest rates and investment rates of return, he added. Furthermore, the government can provide new market rates without the need to issue regulations for notice and comment. He noted that plans can use other rates that are capped by the permitted rates on the exclusive list.

Bostick said the government received comments asking that any rate available in the market be treated as a “market” rate. The Treasury decided that this approach would not provide enough guidance for employers and provide an appropriate scheme for the IRS to enforce. Although it rejected this approach, he noted that the government has the authority to add permitted rates that are appropriate or that people really need. A key element of the exclusive list was that it had a statutory minimum of zero, without losses, Weller said. The rules require that the underlying investment cannot be too volatile. Thus, plans cannot have a single stock investment; options may not work either, he added.

Shea commented, and Weller agreed, that the government has embraced the concept of a diversified portfolio. For example, the plan can invest in a diversified mutual fund. The requirement for broad-based diversification is designed to reduce volatility. While some volatility is permissible, over the long term, a plan is not likely to have a negative return, he said.

The law provides for minimum rates of return on an annual basis and a cumulative basis, according to Shea. Weller said that an annual minimum is difficult to find in the marketplace, but it could be added if there were sufficient demand for combinations of annual minimums, with a haircut. Weller added that the rates should provide enough savings to provide for higher minimum rates, without exceeding the market rates. This would support a higher fixed rate of return.

The regulations address permitted interest rates, Weller noted. The Pension Protection Act of 2006 (P.L. 109-280) pushed toward higher permitted rates. Plans can use segment rates as a benchmark or basic rate, he said. Shea pointed out that the permitted interest rates are not the same as the interest rate yields on a bond that fluctuates in value. Weller agreed; the rates do not reflect price changes in the bond. The crediting rate is independent of that value, but cannot be negative, Bostick emphasized.

Shea noted that the law providing for hybrid plans was enacted in 2006, but the latest regulations were not issued until 2014. Some commentators have suggested that the Treasury and the IRS do not share Congress’s interest in providing hybrid plans. Bostick responded that the Treasury believes that hybrid plans are important, with their potential to provide greater security for employees and to reduce risk for employers. Since 2006, the government has issued several notices, proposed regulations and final regulations for some important issues. With the latest regulations, “we’re well on our way” to providing comprehensive guidance on these plans, Bostick said.

Source: Remarks by Treasury Benefits Tax Counsel George Bostick to the American Bar Association’s Joint Committee on Employee Benefits.

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