Cash balance plan may change its interest-rate lookback month

Plain-English summary

A tax-exempt health system had converted its traditional defined benefit pension plan into a cash balance plan while protecting benefits earned under the old formula. It wanted to use September as the interest-rate lookback month for all present-value calculations, including calculations of protected pre-conversion benefits. During the amendment's first year, the plan would use whichever of the old or new lookback months produced the larger distribution, then use September afterward. The IRS explained that changing an actuarial assumption can otherwise impermissibly eliminate a protected optional form of benefit. It ruled that the one-year better-of transition satisfied the exception in Treasury Regulation section 1.417(e)-1(d)(10)(ii), so the amendment would not violate the cash balance conversion protections in section 411(b)(5).

Ruling snapshot

• Question: May a cash balance plan change the interest-rate lookback month used for protected pre-conversion benefits if it provides a one-year better-of transition?
• Outcome: approved
• Key authorities: IRC §§ 411(b)(5), 411(d)(6), and 417(e)(3); Treas. Reg. §§ 1.411(b)(5)-1 and 1.417(e)-1

Full text (IRS public release)

Internal Revenue Service                                      Department of the Treasury
                                                              Washington, DC 20224

Number: 201803006                                             Third Party Communication: None
Release Date: 1/19/2018                                       Date of Communication: Not Applicable
Index Number: 411.03-01, 417.05-00
                                                              Person To Contact:
------------------------------                                ----------------------, ID No. ------------------
------------------------------------------                    Telephone Number:
---------------------------                                   ----------------------
-----------------------------                                 Refer Reply To:
                                                             CC:TEGE:EB:QP1
In Re: ---------------------------------------------------- PLR-119024-17
------------------------------------------------------------ Date:

-                                                            October 23, 2017




Legend
Plan           =   -----------------------------------------------------------------------
Taxpayer       =   ------------------------------
State X        =   -----------
Date 1         =   ------------------------
Date 2         =   ----------------------
Date 3         =   ------------------------
Year 1         =   -------
Year 2         =   -------

Dear --------------:

This letter is written in response to your request dated June 5, 2017, for a ruling on the
effect of an amendment changing the interest rate lookback month with respect to pre-
conversion benefits under section 411(b)(5) of the Internal Revenue Code of 1986
(“Code”) and the regulations thereunder, following the conversion of a defined benefit
pension plan qualified under section 401(a) to a cash balance plan that is intended to be
a statutory hybrid plan under section 411(a)(13).

In support of your request, you have submitted the following facts and representations
(including a copy of the Plan document) under penalties of perjury.

You have represented that the Taxpayer is a tax-exempt organization under
section 501(c)(3) that operates a health system in State X. The Plan is a defined
benefit plan maintained by the Taxpayer in accordance with section 401(a), and the
Plan’s plan year is the calendar year. The Plan is a single employer plan but covers
employees of multiple related entities that are parties to various collective bargaining
agreements. The Plan has received multiple favorable determination letters, the most
recent of which was issued on Date 1.
PLR-119024-17                                2



The Plan was converted from a traditional defined benefit pension plan to a cash
balance pension plan, generally effective as of Date 2. Prior to Date 2, the Plan
contained numerous benefit formulas for employees of the different entities.

The Plan provides that most active participants have a Cash Balance Effective Date of
Date 2 (although employees participating in the Plan pursuant to one particular
collective bargaining agreement have a Cash Balance Effective Date of Date 3).
Vested terminated participants do not have a Cash Balance Effective Date unless they
are later rehired in covered employment, in which case their Cash Balance Effective
Date is their date of rehire.

The Plan provides that, effective on and after a participant’s Cash Balance Effective
Date, the participant’s Normal Retirement Benefit shall equal the balance of the
participant’s Cash Balance Account, which equals the sum of the participant’s
Conversion Account and the Ongoing Account. With respect to a participant’s
Conversion Account, the Plan provides that, on an eligible participant's Cash Balance
Effective Date, the participant’s accrued benefit is converted to a single sum that is
allocated to the participant’s Conversion Account.

The Plan further provides that the amount of the benefit payable from a participant's
Conversion Account at an annuity starting date, in any form of benefit available under
the Plan, may not be less than the benefit under that form of benefit with respect to
service before the participant’s Cash Balance Effective Date, determined as of that
annuity starting date under the terms of the Plan as in effect immediately before the
Cash Balance Effective Date. Your letter refers to this as the “Protected Benefit.”

Under the terms of the Plan prior to Date 2, present value determinations were based
on interest rates for the lookback month that is the first full calendar month preceding
the Plan Year in which the annuity starting date occurs.

Under the Plan terms made effective on Date 2, the Plan provides:

       (A) For any distribution with an annuity starting date after Year 1 and before Year
       2, the Look-back Month shall be the first full calendar month preceding the Plan
       Year in which the annuity starting date occurs;

       (B) For any distribution with an annuity starting date in Year 2, the Look-back
       Month shall be whichever of the following months results in the larger distribution:

              (i) the first full calendar month preceding the Plan Year in which the
              annuity starting date occurs, or
PLR-119024-17                               3


             (ii) the month of September in the Plan Year preceding the Plan Year in
             which the annuity starting date occurs; and

      (C) For any distribution with an annuity starting date after Year 2, the Look-back
      Month shall be the month of September in the Plan Year preceding the Plan Year
      in which the annuity starting date occurs.

You represent that, for annuity starting dates in Year 2 (referenced in paragraph (B)
above), the September lookback results in the larger distribution.

With respect to determining the present value of a participant’s Protected Benefit, for
participants with a Cash Balance Effective Date of Date 2, the interest rate lookback
month is the first full calendar month preceding the Plan Year in which the annuity
starting date occurs. However, for employees with a Cash Balance Effective Date that
is Date 3, and for rehired vested terminated participants who have an annuity starting
date in or after Year 2, the interest rate lookback month for purposes of determining the
present value of the Protected Benefit is the month of September in the Plan Year
preceding the Plan Year in which the annuity starting date occurs.

You represent that the Taxpayer would like to amend the Plan so that an interest rate
lookback month of September is used for all present value determinations for all
participants, including present value determinations with respect to the Protected
Benefit for participants whose Cash Balance Effective Date is Date 2. You represent
that this change would simplify plan administration and enable the Plan to provide
benefit estimates and benefit distribution paperwork more timely for an annuity starting
date of January 1.

Based on the above facts and representations, you have requested the following ruling:

      The Taxpayer may amend the Plan to provide that the interest rate lookback
      month for present value determinations with respect to Protected Benefits of
      participants with a Date 2 Cash Balance Effective Date will be as follows:
      (a) prior to the effective date of such amendment, which will be on or after the
      date such amendment is adopted, the first full calendar month preceding the Plan
      Year in which the annuity starting date occurs; (b) for the one year period
      commencing on the effective date of the amendment, whichever of the following
      months results in the larger distribution: the first full calendar month preceding
      the Plan Year in which the annuity starting date occurs, or the month of
      September in the Plan Year preceding the Plan Year in which the annuity starting
      date occurs; and (c) following the one year period commencing on the effective
      date of the amendment, the month of September in the Plan Year preceding the
      Plan Year in which the annuity starting date occurs.
PLR-119024-17                                 4


Under section 411(b)(5)(B)(ii), if an amendment to a defined benefit plan is adopted
after June 29, 2005, that has the effect of converting the plan to a cash balance plan,
then the plan is treated as failing to meet the prohibition against age discrimination
under section 411(b)(1)(H) unless the requirements of section 411(b)(5)(B)(iii) of the
Code and § 1.411(b)(5)-1(c)(2) of the Income Tax Regulations are met with respect to
each individual who was a participant in the plan immediately before the adoption of the
amendment.

Section 411(b)(5)(B)(iii) provides that the accrued benefit of a participant under the
terms of the plan as in effect after the amendment may not be less than the sum of
(I) the participant’s accrued benefit for years of service before the effective date of the
amendment, determined under the terms of the plan as in effect before the amendment,
plus (II) the participant’s accrued benefit for years of service after the effective date of
the amendment, determined under the terms of the plan as in effect after the
amendment.

Section 1.411(b)(5)-1(c)(2)(i) provides that, in the case of an individual who was a
participant in the plan immediately before the date of adoption of a conversion
amendment, the participant’s benefit at any subsequent annuity starting date may not
be less than the sum of (A) the participant’s section 411(d)(6) protected benefit (as
defined in §1.411(d)-3(g)(14)) with respect to service before the effective date of the
conversion amendment, determined under the terms of the plan as in effect immediately
before the effective date of the conversion amendment; and (B) the participant’s section
411(d)(6) protected benefit with respect to service on and after the effective date of the
conversion amendment, determined under the terms of the plan as in effect after the
effective date of the conversion amendment.

Section 1.411(b)(5)-1(c)(2)(ii) provides in pertinent part that, except to the extent
permitted under §1.411(d)-3 or §1.411(d)-4 (or other applicable law), each optional form
of payment provided under the terms of the plan with respect to a participant’s
section 411(d)(6) protected benefit as in effect before the conversion amendment must
be available thereafter to the extent of the plan’s benefits for service prior to the
effective date of the conversion amendment.

Section 1.411(b)(5)-1(c)(3)(ii) provides that if a plan protects benefits attributable to
service before the effective date of the conversion amendment by establishing an
opening account balance, then with respect to an optional form of benefit payable at an
annuity starting date, the plan must provide that the amount of the benefit payable in
that optional form under the lump sum-based benefit formula that is attributable to the
opening hypothetical account balance is not less than the benefit under the comparable
optional form of benefit attributable to the pre-conversion formula. Thus, the participant
must receive a benefit equal to not less than the sum of (1) the benefit attributable to
PLR-119024-17                                  5


post-conversion service and (2) the greater of (i) the benefit attributable to the opening
account balance and (ii) the pre-conversion benefit.

Section 411(d)(6) and § 1.411(d)-3(a)(1) provide generally that, except for exceptions
that are not relevant here, a plan is not a qualified plan if a plan amendment decreases
the accrued benefit of any plan participant.

Section 411(d)(6)(B) provides that a plan amendment that has the effect of reducing or
eliminating an early retirement benefit or a retirement-type subsidy, or eliminating an
optional form of benefit with respect to benefits attributable to service before the
amendment is treated as reducing accrued benefits.

Under § 1.411(d)-3(g)(6)(ii)(A), an optional form of benefit is a distribution alternative
that is available under the plan. Different optional forms of benefit exist if a distribution
alternative is not payable on substantially the same terms as another distribution
alternative. The relevant terms include all terms affecting the value of the optional form,
such as the method of benefit calculation and the actuarial factors or assumptions used
to determine the amount distributed.

Section 417(e)(3)(C) provides that the applicable interest rate for purposes of
determining the minimum present value of a participant’s accrued benefit is the adjusted
first, second and third segment rates applied under rules similar to the rules applied in
section 430(h)(2)(C) for the month before the date of the distribution or such other time
as prescribed by regulations (the “lookback month”).

Section 1.417(e)-1(d)(1)(i) provides that, for a defined benefit plan, the minimum
present value rules apply to determination of the present value of any accrued benefit,
and the amount of any distribution. In addition, the present value of any optional form of
benefit cannot be less than the present value of the normal retirement benefit
determined in accordance with the minimum present value rules.

Under § 1.417(e)-1(d)(4)(i), the applicable interest rate to be used for a distribution is
the rate determined for the applicable lookback month. The applicable lookback month
for a distribution is the lookback month for the month (or other longer stability period)
that contains the annuity starting date for the distribution. The time and method for
determining the applicable interest rate for each participant’s distribution must be
determined in a consistent manner that is applied uniformly to all participants in the
plan.

Section 1.417(e)-1(d)(4)(ii) requires a plan to specify the period for which the applicable
interest rate remains constant. This stability period may be one calendar month, one
plan quarter, one calendar quarter, one plan year, or one calendar year.
PLR-119024-17                                  6


Section 1.417(e)-1(d)(4)(iii) requires a plan to specify the lookback month that is used to
determine the applicable interest rate. The lookback month may be the first, second,
third, fourth, or fifth full calendar month preceding the first day of the stability period.

Section 1.417(e)-1(d)(10)(i) provides that plan amendments changing the applicable
interest rate or the time for determining the interest rate are subject to the prohibitions
against the reduction or elimination of protected benefits under section 411(d)(6),
including optional forms of benefits.

Section 1.417(e)-1(d)(10)(ii), however, provides an exception to the general rule under
§ 1.417(e)-1(d)(10)(i). For a plan amendment to be eligible for this exception, if the
amendment is effective on or after the adoption date, then any distribution for which the
annuity starting date occurs in the one-year period commencing at the time the
amendment is effective must be determined using the interest rate provided under the
plan determined at either the date for determining the interest rate before the
amendment or the date for determining the interest rate after the amendment,
whichever results in the larger distribution.

The Taxpayer’s proposed amendment would modify the interest rate lookback month
with respect to present value calculations of Protected Benefits for participants with a
Cash Balance Effective Date of Date 2, and, therefore, such calculations would no
longer be determined under the terms of the Plan as in effect immediately before the
Cash Balance Effective Date, as required by 1.411(b)(5)-1(c)(2)(i) (a participant’s
section 411(d)(6) protected benefit with respect to service before the effective date of
the conversion amendment must be determined under the terms of the plan as in effect
immediately before the effective date of the conversion amendment).

In addition, § 1.411(b)(5)-1(c)(2)(ii) provides that each optional form of payment
provided under the terms of the plan with respect to a participant’s section 411(d)(6)
protected benefit as in effect before the conversion amendment must be available
thereafter to the extent of the plan’s benefits for service prior to the effective date of the
conversion amendment, except to the extent elimination or reduction of the benefit is
permitted under §1.411(d)-3 or §1.411(d)-4 (or other applicable law).

Pursuant to § 1.411(d)-3(g)(6)(ii)(A), amending the lookback month is a modification of
the actuarial factors for determining the present value of a participant’s benefit that
would impermissibly eliminate a previously available optional form of benefit in violation
of section 411(d)(6) unless an exception applies. Section 1.417(e)-1(d)(10)(ii) provides
such an exception. Under § 1.417(e)-1(d)(10)(ii), amendments changing from one
permitted lookback month to another permitted lookback month do not violate section
411(d)(6) or section 417(e) provided the participants receive the benefit of either the
pre-amendment month or the post-amendment month for a one-year period
PLR-119024-17                                7


commencing on the effective date of the amendment, whichever results in the larger
distribution.

Section 1.417(e)-1(d)(10)(i) states that paragraph (d)(10) specifically applies to the
purposes in paragraph (d)(1), namely determination of the present value of any accrued
benefit, and the amount of any distribution, as well as the determination of whether the
present value of any optional form of benefit is not less than the present value of the
normal retirement benefit. The determination of the present value of a participant’s
Protected Benefit is a determination of the present value of an optional form of benefit
and therefore is covered by § 1.417(e)-1(d)(10)(ii). Because “other applicable law” for
purposes of 1.411(b)(5)-1(c)(2)(ii) includes the rules governing the determination of
present value under section 417(e)(3) and § 1.417(e)-1(d)(10)(ii), the terms of the plan
amendment, as represented by the Taxpayer, are consistent with the requirements of
§ 1.411(b)(5)-1(c)(2).

Accordingly, we conclude that the proposed amendment, as described above, to the
Plan’s interest rate lookback month for present value determinations with respect to
Protected Benefits of participants whose Cash Balance Effective Date is Date 2 will not
cause the Plan to violate the requirements of section 411(b)(5)(B)(ii) or (iii).

The ruling contained in this letter is based upon information and representations
submitted by Taxpayer and accompanied by a penalty of perjury statement executed by
an appropriate party, as specified in Rev. Proc. 2017-1, § 7.01(15)(b). This office has
not verified any of the material submitted in support of the request for ruling, and such
material is subject to verification on examination. The Associate office will revoke or
modify a letter ruling and apply the revocation retroactively if there has been a
misstatement or omission of controlling facts; the facts at the time of the transaction are
materially different from the controlling facts on which the ruling was based; or, in the
case of a transaction involving a continuing action or series of actions, the controlling
facts change during the course of the transaction. See Rev. Proc. 2017-1, § 11.05.

Except as expressly provided herein, no opinion is expressed or implied concerning the
tax consequences of any aspect of any transaction or item discussed or referenced in
this letter.

This ruling is directed only to the taxpayer requesting it. Section 6110(k)(3) provides
that it may not be used or cited as precedent.
PLR-119024-17                                  8


In accordance with the Power of Attorney on file with this office, a copy of this letter is
being sent to your authorized representative.

                                           Sincerely,



                                           Laura B. Warshawsky
                                           Chief, Qualified Plans Branch 1
                                           Office of the Associate Chief Counsel
                                           (Tax Exempt & Government Entities)




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