Northeast Benefits Conference 2008

1. Northeast Benefits Conference 2008 Cash Balance and Other hot DB Topics by Jim Holland

2. Cash Balance Issues • PPA changes • Issues on moratorium cases

3. Overview of PPA Changes • New age discrimination provisions • New lump sum provisions • New vesting rules • New definition of hybrid plan

4. Code Sections Added • Section 411(a)(13) - reverses whipsaw effect, but increases vesting • Section 411(b)(5) – generally clarifies age discrimination but other rules as well

5. Guidance Issued • Pre-PPA • Notice 96-8 • Post-PPA • Rev Rul 2007-6 • Rev Rul 2008-6 (not part of discussion) • Proposed regulations

6. Post-PPA Terminology • Applicable defined benefit plan • Statutory hybrid plan (2007-6) • Lump sum-based plan (2007-6) • Statutory hybrid benefit formula • Lump sum-based benefit formula • Accumulated benefit

7. Hierarchy • Statutory hybrid plan • Statutory hybrid formula • Lump sum-based formula

8. Section 411(a)(13) • (A) An applicable defined benefit plan not treated as failing to meet 411(a)(2), or 411(c), or 417(e) solely because the present value of the accrued benefit (or any portion thereof) is, under the terms, of the plan equal to the balance of hypothetical account or accumulated percentage of final average pay

9. Section 411(a)(13) • (B) – An applicable defined benefit plan shall be treated as meeting 411(a)(2) only if an employee with 3 years of service is 100 percent vested in benefit derived from employer contributions

10. Section 411(a)(13) • (C) – Defines “applicable defined benefit plan” as a DB plan under which the accrued benefit (or any portion thereof) is calculated as the balance of a hypothetical account maintained for the participant or as an accumulated percentage of final average pay. Secretary shall issue regs which include in definition any plan with similar effect

11. Proposed Regs • Issued December 28, 2007 • Do not use the term “applicable defined benefit plan” • Define “statutory hybrid plan” as a DB plan that contains a “statutory hybrid benefit formula”

12. Proposed Regs • Define “statutory hybrid benefit formula” as a benefit formula that is either • a lump sum-based benefit formula or • a formula that is not but has an effect similar to a lump sum-based benefit formula

13. Proposed Regs • Define “lump sum-based benefit formula” as a benefit formula used to determine all or any part of a participant’s “accumulated benefit” under a DB plan under which the benefit is expressed as the balance of a hypothetical account or as the current value of the accumulated percentage of final average compensation

14. Proposed Regs • Define “accumulated benefit” as the participant’s benefit as expressed under the terms of the plan accrued to date. May be expressed as either balance of hypothetical account or current value of accumulated percentage of final average pay

15. Proposed Regs • Effect similar to a lump sum-based benefit formula – if the plan provides that the accumulated benefit payable at NRA is expressed as a benefit that includes the right to periodic adjustments (including a formula that provides for indexed benefits) that is reasonably expected to result in a smaller benefit at NRA than for a similarly situated younger individual

16. Proposed Regs • Effect similar to a lump sum-based formula cont. – Repeated plan amendments adjusting benefits can that have same effect and such plans are included. • Post-retirement COLAs excluded • Variable annuity benefit formulas excluded only if assumed interest rate at least 5 percent

17. 100 Percent Vesting • Under proposed regs the 100 percent vesting requirement applies to the entire accrued benefit under a DB plan if any portion of the accrued benefit is determined under a statutory hybrid formula • Includes if greater of two benefits where only one is a statutory hybrid formula

18. Section 411(b)(5)(A) • New age discrimination rules – • Plan not treated as failing to meet 411(b)(1)(H)(i) if participant’s accrued benefit would be equal to or greater than that of any similarly situated younger individual who is or could be a participant • Similarly situated if such participant is identical in every respect except for age

19. Section 411(b)(5)(A) • For purposes of this subparagraph • Accrued benefit may, under terms of the plan, be • Annuity at NRA • Balance of hypothetical account • Current value of accumulated percentage pay

20. Section 411(b)(5)(B) • Applicable DB plans – interest credits • Treated as failing to meet the requirements of 411(b)(1)(H) unless terms of plan provide that any interest credit (or equivalent amount) not greater than a market rate of return • Plan may provide for a reasonable minimum guaranteed rate of return, or rate that is equal to greater of fixed or variable rate

21. Section 411(b)(5)(B) • Applicable DB plans – interest credits • An interest credit of less than zero shall in no event result in account balance or similar amount being less than the aggregate amount of contributions credited • Preservation of capital rule

22. Section 411(b)(5)(B) • Applicable DB plans – interest credits • Secretary may provide by regs for rules governing calculation of a market rate of return, and • For permissible methods of crediting interest to the account resulting in effective rates of return meeting above

23. Section 411(b)(5)(B) • Special rule for conversions after June 29, 2005 • Plan treated as failing to meet 411(b)(1)(H) unless (iii) is met

24. Section 411(b)(5)(B) • (iii) – Accrued benefit under terms of plan after amendment is not less than sum of • AB for years of service before effective date of amendment, determined under terms of plan before amendment, plus • AB for years of service after effective date of amendment, determined under terms of plan after amendment (under cash balance only)

25. AKA • A + B Rule

26. Section 411(b)(5)(E) • Plan not treated as failing 411(b)(1)(H) solely because the plan provides for indexing of accrued benefits under the plan • Except in case of variable annuity, this does not apply to indexing which results in loss of accrued benefit determined without indexing

27. Statutory Effective Date • These changes made by section 701(b) of PPA • Section 701(d) provides that nothing in the amendments made by section 701 should be construed to create an inference concerning the treatment of applicable DB plans or conversions, or whether the plan fails to meet 417(e) as in effect before these amendments

28. Statutory Effective Date • Generally, applies to periods after June 29, 2006 • 411(a)(13)(A) relief effective for distributions made after August 17, 2006

29. Proposed Regulations • Issued December 28, 2007 • Addressed the following: • Definitions – used for both • A +B conversion • Lump sum relief • Indexed benefits • Market rate of return (partially)

30. Proposed Regulations • A + B conversion • The B piece starts at end of A piece • So, if grandfather benefit continues, B piece picks up when grandfather stops • 1% per year through date 3 years after conversion, B piece starts at end of 3 years • No wearaway allowed

31. Proposed Regulations • A + B cont. • Defined effective date of a conversion amendment as date the reduction in benefits under the old formula occurs • If opening account balance based on AB on conversion date, must test total AB later against sum of AB from conversion date plus AB plus (cash balance) benefit for periods after conversion date

32. Proposed Regulations • Lump sum relief – Repeated statute – applies for periods on or after June 29, 2007 • Reg would apply for plan years beginning on or after January 1, 2009

33. Proposed Regulations • Indexed benefits – Not fail 411(b)(H) solely because a benefit formula (that is not a lump sum–based benefit formula) provides for periodic adjustment of AB by means of a recognized investment index or methodology

34. Proposed Regulations • Recognized investment index • Eligible cost-of-living index from 1.401(a)(9)-6 Q&A-14(b) • Rate of return on the aggregate assets of the plan • Rate of return on the annuity contract issued by an insurance company • Must preserve capital

35. Proposed Regulations • Market rate of return • Terms of plan must provide rate not greater than market rate • Considered interest if not conditioned on service • Hypothetical contribution – any amount contributed under a statutory hybrid plan that is not an interest credit

36. Proposed Regulations • Market rate of return • Single rate that is • Long-term corporate bonds, which is defined as 3rd segment rate in section 430(h)(2)(C)(iii) • Notice 96-8 safe harbor rate plus margins (now put into regs) • Rate of increase in eligible cost-of-living index plus 300 basis points

37. Proposed Regulations • Market rate of return • Single rate cont. • Reserved reasonable minimum guaranteed rate and equity-based rates • Combination of rates • Reserved the combinations including greater of a fixed or a variable rate of return

38. Cons ABC ERIC Chamber of Commerce Consulting firms Pros AARP Comments on Proposed Regs

39. D-Day • Hearing on proposed regs held on June 6, 2008 (the 64th anniversary of the Normandy invasion)

40. Issues on Moratorium Cases • Failure of cash balance formula to satisfy accrual rules – minimum interest rate • Problems with definition of accrued benefit • Lump issues (i.e., “whipsaw”)

41. Questions