Regulations Provide Whipsaw Calculation Safe Harbor for Cash

©2011 Wolters Kluwer. All rights reserved. 1 Benefit Practice Portfolios, Regulations Provide Whipsaw Calculation Safe Harbor for Cash Balance Plans (November 2011) Click to open document in a browser By Brian A. Benko ©2011 CCH. All Rights Reserved. Brian A. Benko is an Associate with the law firm of McDermott Will & Emery LLP, Washington, DC. As a member of the Benefits, Compensation, Labor & Employment Practice Group, Mr. Benko counsels clients on a variety of employee benefits matters related to pension plans, cash balance plans, 401(k) plans, executive compensation arrangements, and cafeteria and welfare plans. For additional information please contact Brian A. Benko at bbenko@mwe.com or (202) 756-8047. INTRODUCTION The Pension Protection Act of 2006 (the "PPA") added Section

411(a)(13) to the Internal Revenue Code of 1986, as amended (the "Code").1 Congress enacted Code Section 411(a)(13) to eliminate the "whipsaw calculation" for cash balance plans.2 Prior to the PPA, cash balance plans used the whipsaw calculation to convert a hypothetical account balance to an annuity payable at normal retirement age, and, then, discount the annuity to a lump sum. Code Section 411(a)(13) provides a safe harbor allowing a cash balance plan to distribute the current hypothetical account balance in the form of a lump sum distribution. Since Congress enacted the PPA in 2006, practitioners have struggled to apply the rules to cash balance plans—as the Treasury Department and the Internal Revenue Service (the "IRS") drafted regulations. In 2007, a set of proposed regulations interpreted the requirements for taking advantage of the whipsaw calculation safe harbor under Code Section 411(a)(13).3 On October 19, 2010, the Treasury Department and the IRS issued final regulations, which generally adopted the 2007 proposed regulations, and new proposed regulations.4 The new 2010 proposed regulations proffered new conditions and requirements for applying the whipsaw safe harbor. This Article explains the impact of the 2010 final and proposed regulations under Code Section 411(a)(13) on cash balance plans. The first part provides background on the fundamental features of cash balance plans, and reviews the scope of the 2010 final and proposed regulations. The second part analyzes the new 3-year cliff minimum vesting schedule for cash balance plans. The third part explains the whipsaw calculation-related rules and conditions included in the 2010 final and proposed regulations. The fourth part discusses the statutory effective dates and regulatory applicability dates for Code Section 411(a)(13). CASH BALANCE PLANS UNDER THE FINAL AND PROPOSED REGULATIONS The final regulations contain rules establishing the scope of the plans affected by the vesting and whipsaw calculation requirements under Code Section 411(a)(13). Statutory hybrid plans must comply with the requirements under Code Section 411(a)(13).5 A statutory hybrid plan is a type of defined benefit plan. The defining characteristic of a statutory hybrid plan is the type of formula used to determine a participant's benefit. For purposes of this Article, the benefit formula is called a statutory hybrid benefit formula that is a lump sum based-benefit formula. A plan need not include a lump-sum payment option to be a statutory hybrid plan.6 In general, cash balance plans use a lump sum based-benefit formula to determine a participant's benefit...

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