space
Fox & Fox
space space space space space space space
space space
space space

Questions and Answers

What is a hybrid pension plan?

A hybrid pension plan is a defined benefit plan that has certain attributes normally associated with a defined contribution (or individual account) plan. Informally, a defined benefit plan formula defines the benefit to be paid from the plan, while a defined contribution plan formula defines the contributions to be made to an individual participant's account under the plan. More formally, the terms individual account plan and defined contribution plan are defined by law as "a pension plan which provides for an individual account for each participant and for benefits based solely upon the amount contributed to the participant's account, and any income, expenses, gains and losses, and any forfeitures of accounts of other participants which may be allocated to such participant's account." [ERISA § 3(34)] The term defined benefit plan is defined as "a pension plan other than an individual account plan." Special rules apply to contributory defined benefit plans to which participants make contributions to an individual account. [ERISA § 3(35)]
Hybrid pension plans are defined benefit plans in that no individual accounts exist within the trust holding the assets. Benefit formulas are instead defined as a notional account for each participant. From a participant perspective, the benefit is viewed as a lump-sum amount similar to a defined contribution plan account balance. Unlike defined contribution plans, contributions to a hybrid plan are made in aggregate to fund the benefits under the plan and not tied or allocated directly to individual participants in the plan. Although contributory cash balance plans exist, they are rare and would be considered a form of contributory defined benefit plan, subject to the rules for contributory defined benefit plans.
Internal Revenue Code Section 414(k), which predates enactment of the PPA, provides for a type of defined benefit plan that provides "a benefit derived from employer contributions which is based partly on the balance of the separate account of a participant...." Because the benefit is not "based solely upon the amount contributed to the participant's account," a 414(k) plan is a defined benefit plan [ERISA § 3(34)] However, the hybrid plan rules established by the PPA apply to a participant's hypothetical account (or an accumulated percentage of final average compensation, under a pension equity plan). Because the 414(k) plan benefit is based at least in part on the balance of the (actual) separate account of a participant, a 414(k) plan presumably would not be treated as a hybrid pension plan under those hybrid plan rules, unless the part of the benefit not based on the separate account of a participant is based on a statutory hybrid benefit formula. One of the few IRS items of guidance cites to Internal Revenue Code Section 414(k) as permitting a floor-offset plan, which provides that the benefit under a defined benefit plan be offset by the benefit under a defined contribution plan. [IRS Rev. Rul. 76-259] However, the instructions to Form 5500 (Annual Report/Return of Employee Benefit Plan) list the 414(k) plan and floor-offset plan as separate coding choices when indicating the applicable characteristics of the plan for which the form is being filed. In any event, 414(k) plans are rare.

Go to Questions and Answers Pagetop

What is the definition of hybrid benefit plans under the PPA?

Prior to the PPA, no specific definition of hybrid benefit plan existed. Within the rules related to hybrid plans, the PPA defines applicable defined benefit plan. An applicable defined benefit plan (or, for purposes of this book, a hybrid defined benefit plan or, simply, a hybrid plan) is any plan that defines the accrued benefit, or a portion of the accrued benefit, in the form of a hypothetical account balance (such as a cash balance plan) or as an accumulated percentage of a participant's final average compensation (as in a pension equity plan). As part of the PPA, the Secretary of the Treasury is directed to issue regulations to define an applicable defined benefit plan to include any defined benefit plan that has a similar effect to an applicable defined benefit plan as statutorily defined.
The Internal Revenue Service uses the term statutory hybrid plan to refer to an applicable defined benefit plan and any plan that has an effect similar to an applicable defined benefit plan. [IRS Notice 2007-6, part II] A statutory hybrid plan is defined as a defined benefit plan that contains a statutory hybrid benefit formula. [Prop. Treas. Reg. § 1.411(b)(5)-1(e)(5)] A statutory hybrid benefit formula is a lump-sum-based benefit formula or a formula that has a similar effect, but is not a lump-sum-based benefit formula. [Prop. Treas. Reg. § 1.411(a)(13)-1(d)(3)(i)] A lump-sum based benefit formula is a benefit formula used to determine all, or any portion, of a participant's accumulated benefit based on a formula expressed as the balance of a hypothetical account maintained for the participant or as the current value of the accumulated percentage of the participant's final average compensation, regardless of whether the plan actually provides a lump-sum optional form of benefit payment. However, merely the fact that a participant in a contributory defined benefit plan is entitled to a benefit equal to the greater of the benefit properly attributable to after-tax employee contributions or the otherwise applicable benefit formula under the plan, in and of itself, does not subject the contributory defined benefit plan to treatment as having a lump-sum-based benefit formula. [Prop. Treas. Reg. § 1.411(b)(5)-1(e)(3)]
A participant's accumulated benefit at any date is the participant's benefit, as expressed under the terms of the plan, accrued to that date. The participant's accumulated benefit can be expressed under the terms of the plan as either the (current) balance of a hypothetical account maintained for the participant or the current value of the accumulated percentage of the participant's final average compensation, even if the plan defines the participant's accrued benefit as an annuity beginning at normal retirement age that is the actuarial equivalent of such a balance or value. [Prop. Treas. Reg. § 1.411(b)(5)-1(e)(2)] The term accumulated benefit is intended to distinguish the "benefit accrued to date" [I.R.C. § 411(b)(5)(G)], which can be expressed as either the current value of the accumulated percentage of final average compensation, the (current) balance of a hypothetical account, or as an annuity payable at normal retirement age for purposes of the age discrimination rules of the PPA, from the accrued benefit [I.R.C. § 411(a)(7)(A)(i)], which can generally only be expressed as an annuity payable at normal retirement age for other purposes.
A defined benefit plan formula (that is not a lump-sum-based benefit formula) has an effect similar to a lump-sum-based benefit formula if it expresses a participant's accumulated benefit payable at normal retirement age (or at benefit commencement, if later) as a benefit that includes the right to periodic adjustments (including due to indexing under Prop. Treas. Reg. § 1.411(b)(5)-1(b)(2)) reasonably expected to result in a smaller annual benefit for the participant than for a similarly situated, younger individual who is, or could be, a participant in the plan. The rule of the prior sentence applies even if the adjustments are provided pursuant to a pattern of repeated plan amendments. [Prop. Treas. Reg. § 1.411(a)(13)-1(d)(3)(ii)] Adjustments after the participant's annuity starting date, such as cost of living increases, are disregarded for purposes of determining whether a defined benefit plan formula has an effect similar to a lump-sum-based benefit formula. If the interest rate assumed for purposes of adjusting amounts payable to a participant under a variable annuity benefit formula, as defined under Prop. Treas. Reg. § 1.411(a)(13)-1(d)(4), is at least 5 percent, then the variable annuity benefit formula does not have an effect similar to a lump-sum-based benefit formula. A defined benefit plan formula that (merely) provides for a benefit equal to the benefit properly attributable to after-tax employee contributions does not have an effect similar to a lump-sum-based benefit formula. [Prop. Treas. Reg. § 1.411(a)(13)-1(d)(3)(iii)]

Go to Questions and Answers Pagetop

What is a hybrid plan with a lump-sum-based plan?

PPA creates a statutory definition of a hybrid plan and defines it as "a defined benefit 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 the participant's final average compensation." [PPA §§ 701(a)(2), 701(b)(2), 701(c)] (Note that the statute actually uses the term applicable defined benefit plan instead of hybrid plan.) The statutory changes of the PPA also direct the Treasury to include in the definition of hybrid plan "any defined benefit plan (or any portion of the plan) which has an effect similar to" a hybrid plan. [I.R.C. § 411(a)(13)(C); ERISA § 203(f)(3); ADEA § 4(i)(10)(B)(v)(IV)] The term statutory hybrid plan refers to an applicable defined benefit plan and any plan that has an effect similar to an applicable defined benefit plan. [IRS Notice 2007-6, § III.A.1] Transition guidance appeared to substitute the term lump-sum-based plan for applicable defined benefit plan, in the prior sentence. In turn, the proposed regulations appear to have replaced the notion of a lump-sum-based plan with the notion of a lump-sum-based formula within a statutory hybrid plan, as described in the following paragraph.
A statutory hybrid plan is defined as a defined benefit plan that contains a statutory hybrid benefit formula. [Prop. Treas. Reg. § 1.411(b)(5)-1(e)(5)] A statutory hybrid benefit formula is a lump-sum-based benefit formula or a formula that has a similar effect, but is not a lump-sum-based benefit formula. [Prop. Treas. Reg. § 1.411(a)(13)-1(d)(3)(i)] A lump-sum-based benefit formula is a benefit formula used to determine all, or any portion, of a participant's accumulated benefit based on a formula expressed as the balance of a hypothetical account maintained for the participant or as the current value of the accumulated percentage of the participant's final average compensation, regardless of whether the plan actually provides a lump-sum optional form of benefit payment. However, merely the fact that a participant in a contributory defined benefit plan is entitled to a benefit equal to the greater of the benefit properly attributable to after-tax employee contributions or the otherwise applicable benefit formula under the plan, in and of itself, does not subject the contributory defined benefit plan to treatment as having a lump-sum-based benefit formula. [Prop. Treas. Reg. § 1.411(b)(5)-1(e)(3)]
A defined benefit plan formula (that is not a lump-sum-based benefit formula) has an effect similar to a lump-sum-based benefit formula if it expresses a participant's accumulated benefit payable at normal retirement age (or at benefit commencement, if later) as a benefit that includes the right to periodic adjustments (including due to indexing under Proposed Treasury Regulations Section 1.411(b)(5)-1(b)(2)) reasonably expected to result in a smaller annual benefit for the participant than for a similarly situated, younger individual who is, or could be, a participant in the plan. The rule of the prior sentence applies even if the adjustments are provided pursuant to a pattern of repeated plan amendments, rather than through the benefit formula itself. [Prop. Treas. Reg. § 1.411(a)(13)-1(d)(3)(ii)] Adjustments after the participant's annuity starting date, such as cost of living increases, are disregarded for purposes of determining whether a defined benefit plan formula has an effect similar to a lump-sum-based benefit formula. A defined benefit plan formula that (merely) provides for a benefit equal to the benefit properly attributable to after-tax employee contributions does not have an effect similar to a lump-sum-based benefit formula. If the assumed interest rate, for purposes of adjusting amounts payable to a participant under a variable annuity benefit formula, is at least 5 percent, then the variable annuity benefit formula does not have an effect similar to a lump-sum-based benefit formula. [Prop. Treas. Reg. § 1.411(a)(13)-1(d)(3)(iii)] A variable annuity benefit formula is any formula under a defined benefit plan that periodically adjusts the amount payable by reference to the difference between the rate of return of plan assets (or specified market indices) and a specified assumed interest rate. [Prop. Treas. Reg. § 1.411(a)(13)-1(d)(4)]
There is some concern that, without clarification, the definition of a lump-sum-based benefit formula could sweep in plan designs to which the proposed hybrid plan regulations are not intended to apply, such as contributory defined benefit plans or plans that define the benefit as a term-certain annuity.

Go to Questions and Answers Pagetop

What is a notional account?

A notional account is a bookkeeping account. Whereas a defined contribution plan has individual accounts with dollars in a trust that are specifically earmarked as the assets of each individual participant's defined contribution account, a cash balance plan account does not. Like the formula in a traditional defined benefit plan (such as a final average pay or dollars times service plan), the formula determining the notional account only defines the benefit to be paid to a participant and is backed up by the total assets in the pension trust. Yet, at any one point in time, the assets in the trust will be more or less than the sum of all the cash balance accounts accrued by participants in the plan.

Go to Questions and Answers Pagetop

When is a pay (or service) credit accrued?

Plan rules can vary on this point. Generally, a plan is designed so that the pay credits are credited to a participant's notional account periodically throughout the year, assuming any requirements for receiving a pay credit are met. Credits can accrue annually, quarterly, monthly, or even daily. Requirements for receiving a pay credit could include working at least a certain number of hours (such as 1,000 hours) or being active at the end of the period for which the pay credit is being made in order to earn the accrual. In those cases, if employees are required to be active at the end of the period to receive an accrual, plans may also provide for the pay credits in the event the employee retires during the period or becomes disabled.

If an employee terminates during the period, the plan could provide no pay credit if the requirement to be active at the end of the period is not met. Many plans, however, provide a pay credit for the time the employee was active during the period.

Go to Questions and Answers Pagetop

What is a frontloaded interest credit cash balance plan?

A participant in a cash balance plan typically accrues his or her account balance through pay credits and interest credits. Pay credits are earned while the employee is an active participant, meaning he or she is employed by the plan sponsor. A plan is considered to have frontloaded interest credits if interest credits continue to accrue whether or not a participant is still an active participant. In other words, if a participant terminates employment, interest credits will continue until the participant eventually takes a distribution.

Go to Questions and Answers Pagetop

space space
space space

Access Your Flex Benefit Account

Access Administrative Forms

Contact Us

pdfClick here to Download Adobe Acrobat Reader

space
space
space