Specialized Qualified Plans — Cash Balance, Target, Age-Weighted and Hybrids discusses different types of retirement plans including alternative or hybrid plan designs. This Portfolio, written by Kyle N. Brown, discusses the universe of defined benefit pension plans, which is composed primarily of pay and service-related defined benefit plans such as traditional final pay and career average plans. It also discusses the universe of defined contribution plans, which is made up of traditional profit-sharing plans [including §401(k) elective deferral plans and §401(m) matching contribution plans] and money purchase pension plans. 

Alongside these traditional plan designs, a number of alternative, or hybrid, plan designs have evolved that are the subject of this Portfolio. These include target benefit plans, age-weighted profit-sharing plans, points plans, cash balance plans, pension equity plans, floor-offset plans, and §414(k) plans. Each of these plan designs attempts to marry some of the characteristics of a more traditional defined benefit plan with some of the characteristics of a more traditional defined contribution plan.  

The Portfolio includes brief descriptions of each type of plan: 

• Target benefit plans: defined contribution pension plans in which the allocation to a participant's account is determined by reference to the amount projected to fund the targeted benefit under the plan.
• Age-weighted profit-sharing plans: defined contribution plans in which the allocation is usually specified by schedule and increases based on age or a combination of age and service. 
• Points plans: defined contribution plans in which the allocation is based on points credited because of age, service, compensation, or a combination thereof.
• Cash balance plans: defined benefit plans in which the formula benefit under the plan is described in terms of a hypothetical or notional account balance. 
• Pension equity plans: defined benefit plans in which the formula benefit under the plan is described as a lump-sum amount based on the participant's final average compensation and service. Participants earn points or credits that are accumulated and applied to final average compensation to determine the formula lump-sum amount. It is not uncommon for points or credits under a pension equity plan, or PEP, to increase with a participant's age or service.
• Floor-offset plans: arrangements including both a defined benefit plan and a defined contribution plan. An employee's benefit in the defined benefit plan is reduced, or offset, by the actuarial equivalent of the employee's account balance in the defined contribution plan.
• §414(k) plans: hybrid plans that include both a traditional defined benefit and a benefit based on a separate account in the same plan. 

These alternative plan designs are best evaluated only after exploring some of the key features and differences between defined benefit and defined contribution plans.  

Although there are many characteristics of defined benefit and defined contribution plans, Specialized Qualified Plans — Cash Balance, Target, Age-Weighted and Hybrids addresses those that are the most important to evaluating different plan designs. These include the nature of the promise and the allocation of risk; the relative rate, or pattern, of benefit accrual; the effect of §415 limits; and administrative requirements. Special attention is given to various legal issues surrounding cash balance plans. 

This Portfolio also explores the key features of and differences between these contribution plans in an effort to more fully understand the hybrid nature of such alternative plan designs.  Specific topics discussed include  special rule for changes from Pre-TRA 1986 Safe Harbor Formula to a Post-TRA 1986 Safe Harbor Formula, interaction with §415 and top-heavy rules, non-safe harbor designs, cross-testing methodology, actuarial assumptions, and more. 

Specialized Qualified Plans — Cash Balance, Target, Age-Weighted and Hybrids allows you to benefit from:

• Hundreds of hours of original research on specific tax planning topics from leading practitioners in this area
• Invaluable practice documents including tables, charts and lists
• Plain-English guidance from world-class experts
• Real-world and in-depth analysis that lets you explore various options
• Time-saving access to relevant sections of tax laws, regulations, court cases, IRS documents and more
• Alternative approaches to both common and unique tax scenarios

This Portfolio is part of the U.S. Income Portfolios Library, a comprehensive series that includes more than 200 Portfolios, which covers every federal tax topic with expert, in-depth analysis, and offer commentary on a wide range of federal taxation topics, including Compensation Planning, Deductions and Credits, Partnerships and Corporations, Special Pass-Through Entities, Corporate Reorganizations, Real Estate, Procedure and Administration, and more. 

Detailed Analysis

I. Introduction

A. Overview

B. Nature of the Promise

C. Pattern of Benefit Accrual

1. Comparing Benefits from Defined Benefit and Defined Contribution Plans

2. Some Caveats

D. Allocation of Risk

E. Administrative Issues

F. Section 415 Considerations

II. Target Benefit Plans

Introductory Material

A. An Overview

B. Nondiscrimination Safe Harbor

1. Requirements for Safe Harbor Treatment

2. Setting the Target Benefit Formula

a. Flat Benefit

b. Unit Credit

c. Integrating the Formula

d. Defining Compensation in the Formula

e. Permitted Non-Uniformities

3. Determining the Contributions

a. In General

b. The Parameters of the Funding Determination

c. Determining Contributions After Normal Retirement Age

4. Crediting Service, Including Past Service, Under a Target Plan

a. The General Rule Against Past Service

b. Past Service Exception

5. Changing a Target Plan

a. Changing the Target Benefit Formula

b. Changing a Safe Harbor Formula to Another Safe Harbor Formula

c. Changing from a Non-Safe Harbor Target Plan to a Safe Harbor Target Plan

d. Special Rule for Changes from Pre-TRA 1986 Safe Harbor Formula to a Post-TRA 1986 Safe Harbor Formula

e. Changing the Interest Rate

6. Interaction with § 415 and Top-Heavy Rules

a. Effect of § 415

b. Top-Heavy Rules

C. Nonsafe Harbor Designs

III. Age-Weighted Profit-Sharing Plans

A. The Basic Plan Design

1. Background - The Nondiscrimination Rules

2. The Implicit Safe Harbor

3. Comparison with Traditional Profit-Sharing Design

4. Using Permitted Disparity in the Age-Weighted Formula

5. Overall Benefit Delivery of an Age-Weighted Design

B. Specifics of Cross-Testing

1. Cross-Testing Methodology

2. Actuarial Assumptions

3. Compensation

4. Employees Working Past Normal Retirement Age

C. Designing and Applying the Implicit Safe Harbor Design

1. Providing a Specific Contribution for a Particular Employee

2. Keying Off Total Contributions

3. Funding Toward a Specified Benefit

D. New Comparability Plans

1. Policy Rationale

2. Cross-Tested Defined Contribution Plan

a. Broadly Available Allocation Rates

b. Age-Based Allocation Rates

c. Minimum Gateway for Cross-Testing

3. Defined Benefit/Defined Contribution Aggregated Plans

a. Primarily Defined Benefit in Character

b. Broadly Available Separate Plans

c. Minimum Gateway Allocations

d. Component Plans and Permitted Disparity

E. Effect of Other Qualification Requirements

1. Effect of § 415 Limits

2. Effect of Top-Heavy

3. Age Discrimination

IV. Points Plans

A. Overview

B. Nondiscrimination

1. General Test and Cross-Testing

2. The Points Plan Safe Harbor

a. In General

b. Requirements

c. Top-Heavy Requirements

d. Limitations of Points Plan Safe Harbor

V. Cash Balance Plans

Introductory Material

A. Overview of the Basic Design

1. An Account Based Defined Benefit Plan

2. An Indexed Career Pay Plan

B. Plan Design Considerations

1. Benefit Delivery and Cost

2. Employee Acceptance and Communication

3. Defined Benefit Plan Attributes

4. Allocation of Risk and Reward

5. Rate of Pay Credits

6. Setting the Interest Crediting Rate

7. Lump-Sum Benefits

8. Transition Issues

9. Ancillary Benefits

C. Qualification and Legal Issues

1. Accrued Benefit Issues

a. Definitely Determinable Benefits

b. Definition of Accrued Benefit

c. Guaranteed Interest Credits

d. Ad Hoc Interest Credits

e. Changing the Interest Rate or Conversion Factors

f. Vesting Requirements

g. Plan Termination Requirements

2. Age Discrimination

a. Basic Statutory Standard

b. Disparate Treatment v. Disparate Impact

c. IRS Guidance

d. Case Law

e. Revised Standard for Pension Age Discrimination Under the Pension Protection Act of 2006

3. Hybrid Plan Conversions

a. Common Conversion Methods

b. Wear-Away Controversy

c. Legal Standards

d. Revised Minimum Conversion Requirements Under the Pension Protection Act of 2006

4. Back-Loading

5. Calculating Lump-Sum Benefits

a. Application of § 417(e)

b. “Whipsaw” Calculation

c. Elimination of the Whipsaw Calculation

d. Interest Crediting Rates

6. Nondiscrimination Analysis

a. Nondiscrimination Safe Harbor

(1) Interest Credits

(2) Determination of the Accrued Benefit

(3) Other Requirements

b. The General Nondiscrimination Test

(1) In General

(2) Changes in Formula Under the General Test

c. Integrating the Cash Balance Design

d. New Comparability Standards for Cash Balance Plans

7. Section 415 Limits

VI. Pension Equity and other Lump-Sum Retirement Plans

A. Introduction

B. Comparing PEP Plans to Traditional Final Pay Plans and Cash Balance Plans

C. Qualification Issues

1. Definition of Accrued Benefit

2. Calculation of Lump Sum

3. Accrual Rules

4. Nondiscrimination

5. Section 415

6. Age Discrimination

a. In General

b. Revised Standard for Pension Age Discrimination Under the Pension Protection Act of 2006

c. Revised Minimum Conversion Requirements Under the Pension Protection Act of 2006

VII. Floor-Offset Plans

A. Overview

1. History of Floor-Offset Plans

2. Advantages and Disadvantages

B. Qualification Requirements

1. Definitely Determinable

2. Accrual Rules

3. Determining the Offset

4. Restrictions on Using Certain Defined Contribution Plans

a. Plans Subject to § 401(k) and (m)

b. ESOPs and Other Plans Investing in Employer Securities

5. Minimum Coverage

6. Nondiscrimination

a. General Test

b. Safe Harbor

c. Testing Benefits, Rights and Features

7. Section 401(a)(26)

8. Qualified Joint and Survivor Requirements

9. Participant-Directed Investments

10. Employees Working Past Normal Retirement Age

VIII. Section 414(k) Plans

Introductory Material

A. Characteristics of a § 414(k) Plan

1. The Statutory Provision

2. A Single Plan or Two Plans?

3. Defined Benefit or Defined Contribution?

4. Character of the Separate Account

5. Funding the Separate Account

B. Using a § 414(k) Account to Replace Other Defined Contribution Plans, and Funding with Surplus Defined Benefit Plan Assets

1. Description of the Transaction

2. Possible Legal Concerns

a. Reversion Excise Tax

b. Income Tax

c. Exclusive Benefit Rule

d. Matching Contribution

e. IRS Ruling

Working Papers

Table of Worksheets

Worksheet 1 Sample Age-Weighted Profit-Sharing Plan Allocation Language (Excerpt)

Worksheet 2 Age-Weighted Allocation Factors

Worksheet 3 Sample Target Benefit Plan Contribution Language (Excerpt)

Worksheet 4 Table of Present Value Factors and Amortization Factors for Target Benefit Plans

Worksheet 5 Sample Allocation Language for Points Plan (Excerpt)

Worksheet 6 Sample Cash Balance Plan Provisions (Excerpt)

Worksheet 7 Sample Pension Equity Plan Provisions (Excerpt)

Bibliography

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Treasury Regulations:

Treasury Rulings:

Cases:

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