Industry Groups Ask Treasury for Cash Balance Intervention

August 27, 2007 ( - Cash balance plan designs got some much-needed relief from the Pension Protection Act - but existing plans aren't out of the woods yet.

Concerned that the Internal Revenue Service (IRS) will take a dim view of “greater-of-the-two” formulas employed in the conversions of a number of traditional pension plans to cash balance plans, a number of industry organizations have now asked Treasury Secretary Henry Paulson to intervene and “suspend temporarily any adverse actions relating to backloading of benefits resulting from grandfather provisions in hybrid pension plans.”  

The Pension Protection Act (PPA) provided much needed clarity on cash balance plan designs, but only on a prospective basis.   One area specifically not addressed was the interplay, following a conversion, of the accrual rules that restrict “backloading” of benefits with plan provisions that mitigate prospective benefit reductions in conversions by grandfathering (permanently or temporarily) participants in pre-conversion benefit formulas.  

Imminent Threat

The  letter to Paulson notes that “it has come to our attention that the Service is now interpreting the law regarding backloading to prohibit or restrict the use in conversions of grandfather provisions” that have either of the aforementioned effects.   The letter goes on to outline the authors’ understanding that “…the Service may be ruling adversely on the qualification of plans because they include such provisions.”   They cite the existence of different views as to whether this backloading issue can be addressed administratively or whether legislation is required, and that there are perhaps different views as to how this issue should be resolved.   Consequently, they note, “it is important that these critical discussions be pursued without an imminent threat of plan disqualification or elimination of grandfather formulas.”  

Ironically, the formulas were typically put in place to help assure that workers got the better of the benefits offered by the cash balance or traditional pension design.   However, the IRS has been sending signals that it believes such provisions violate “anti-backloading” rules –   which are designed to keep a plan from pushing too much of the benefit accrual to the final years of service.  

The  letter  was signed by AARP, the American Benefits Council, the Business Roundtable, the Coalition to Preserve the Defined Benefit System, the ERISA Industry Committee (ERIC), the National Committee to Preserve Social Security and Medicare, and the Service Employees International Union.

June Correspondence

In June, many of the same organizations were part of a broader  letter writing coalition that expressed concerns to several legislators, including the Chairman and Ranking Members of the Committee on Education and Labor, the House Ways and Means Committee, Senate Finance Committee, and the Senate Health Education, Labor and Pensions.

At that time, according to the letter writers, the IRS was saying, “…in the context of the recently opened determination letter process for hybrid pension plans — that the “greater of” transition approach violates the rules designed to prevent backloading of pension accruals because the increase in benefits is too large when one formula outstrips the other.”   The determination letter process for cash balance plans had been halted for some time prior to the enactment of the PPA.  

In the  June letters  it was noted that, under the IRS interpretation a backloading violation would frequently result when defined benefit plans offer minimum guaranteed benefits, which are often found in multi-employer union plans, because the employee is entitled to the greater of the plan’s regular accruals or the guaranteed minimum benefit. Likewise, backloading violations could occur as a result of acquisitions, when employers often provide employees with the greater of the benefits under the prior employer’s defined benefit plan formula or its own formula.

The letter closed by stating that its authors “…feel strongly that the IRS’s formalistic interpretation does not make sense, is not required by the statute and will do significant harm to defined benefit plan participants and sponsors.”