Additional Rules Regarding Hybrid Retirement Plans, 64197-64216 [2010-25942]

Agencies

• Internal Revenue Service
• DEPARTMENT OF THE TREASURY

[Federal Register Volume 75, Number 201 (Tuesday, October 19, 2010)]
[Proposed Rules]
[Pages 64197-64216]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2010-25942]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[REG-132554-08]
RIN 1545-BI16


Additional Rules Regarding Hybrid Retirement Plans

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking and notice of public hearing.

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SUMMARY: This document contains proposed regulations providing guidance 
relating to certain provisions of the Internal Revenue Code (Code) that 
apply to hybrid defined benefit pension plans. These regulations would 
provide guidance on changes made by the Pension Protection Act of 2006, 
as amended by the Worker, Retiree, and Employer Recovery Act of 2008. 
These regulations would affect sponsors, administrators, participants, 
and beneficiaries of hybrid defined benefit pension plans. This 
document also provides a notice of a public hearing on these proposed 
regulations.

DATES: Written or electronic comments must be received by Wednesday, 
January 12, 2011. Outlines of topics to be discussed at the public 
hearing scheduled for Wednesday, January 26, 2011, at 10 a.m. must be 
received by Friday, January 14, 2011.

ADDRESSES: Send submissions to: CC:PA:LPD:PR (REG-132554-08), Room 
5203, Internal Revenue Service, PO Box 7604, Ben Franklin Station, 
Washington, DC 20044. Submissions may be hand-delivered Monday through 
Friday between the hours of 8 a.m. and 4 p.m. to: CC:PA:LPD:PR (REG-
132554-08), Courier's Desk, Internal Revenue Service, 1111 Constitution 
Avenue, NW., Washington, DC, or sent electronically, via the Federal 
eRulemaking Portal at https://www.regulations.gov (IRS REG-132554-08). 
The public hearing will be held in the IRS Auditorium, Internal Revenue 
Building, 1111 Constitution Avenue, NW., Washington, DC.

FOR FURTHER INFORMATION CONTACT: Concerning the regulations, Neil S. 
Sandhu, Lauson C. Green, or Linda S.F. Marshall at (202) 622-6090; 
concerning submissions of comments, the hearing, and/or being placed on 
the building access list to attend the hearing, Regina Johnson, at 
(202) 622-7180 (not toll-free numbers).

SUPPLEMENTARY INFORMATION:

Background

    This document contains proposed amendments to the Income Tax 
Regulations (26 CFR part 1) under sections 411(a)(13), 411(b)(1), and 
411(b)(5) of the Code. Generally, a defined benefit pension plan must 
satisfy the minimum vesting standards of section 411(a) and the accrual 
requirements of section 411(b) in order to be qualified under section 
401(a) of the Code. Sections 411(a)(13) and 411(b)(5), which modify the 
minimum vesting standards of section 411(a) and the accrual 
requirements of section 411(b), were added to the Code by section 
701(b) of the Pension Protection Act of 2006, Public Law 109-280 (120 
Stat. 780 (2006)) (PPA '06). Sections 411(a)(13) and 411(b)(5), as well 
as certain effective date provisions related to these sections, were 
subsequently amended by the Worker, Retiree, and Employer Recovery Act 
of 2008, Public Law 110-458 (122 Stat. 5092 (2008)) (WRERA '08).
    Section 411(a)(13)(A) provides that an applicable defined benefit 
plan (which is defined in section 411(a)(13)(C)) is not treated as 
failing to meet either (i) the requirements of section 411(a)(2) 
(subject to a special vesting rule in section 411(a)(13)(B) with 
respect to benefits derived from employer contributions) or (ii) the 
requirements of section 411(a)(11), 411(c), or 417(e), with respect to 
accrued benefits derived from employer contributions, merely because 
the present value of the accrued benefit (or any portion thereof) of 
any participant is, under the terms of the plan, equal to the amount 
expressed as the balance of a hypothetical account or as an accumulated 
percentage of the participant's final average compensation. Section 
411(a)(13)(B) requires an applicable defined benefit plan to provide 
that an employee who has completed at least 3 years of service has a 
nonforfeitable right to 100 percent of the employee's accrued benefit 
derived from employer contributions.
    Under section 411(a)(13)(C)(i), an applicable defined benefit plan 
is defined as a defined benefit plan under which the accrued benefit 
(or any portion thereof) of a participant 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. 
Under section 411(a)(13)(C)(ii), the Secretary of the Treasury is to 
issue regulations which include in the definition of an applicable 
defined benefit plan any defined benefit plan (or portion of such a 
plan) which has an effect similar to a plan described in section 
411(a)(13)(C)(i).
    Section 411(a) requires that a defined benefit plan satisfy the 
requirements of section 411(b)(1). Section 411(b)(1) provides that a 
defined benefit plan must satisfy one of the three accrual rules of 
section 411(b)(1)(A), (B), and (C) with respect to benefits accruing 
under the plan. The three accrual rules are the 3 percent method of 
section 411(b)(1)(A), the 133\1/3\ percent rule of section 
411(b)(1)(B), and the fractional rule of section 411(b)(1)(C).
    Section 411(b)(1)(B) provides that a defined benefit plan satisfies 
the requirements of the 133\1/3\ percent rule for a particular plan 
year if, under the plan, the accrued benefit payable at the normal 
retirement age is equal to the normal retirement benefit, and the 
annual rate at which any individual who is or could be a participant 
can accrue the retirement benefits payable at normal retirement age 
under the plan

[[Page 64198]]

for any later plan year is not more than 133\1/3\ percent of the annual 
rate at which the individual can accrue benefits for any plan year 
beginning on or after such particular plan year and before such later 
plan year.
    For purposes of applying the 133\1/3\ percent rule, section 
411(b)(1)(B)(i) provides that any amendment to the plan which is in 
effect for the current year is treated as in effect for all other plan 
years. Section 411(b)(1)(B)(ii) provides that any change in an accrual 
rate which does not apply to any individual who is or could be a 
participant in the current plan year is disregarded. Section 
411(b)(1)(B)(iii) provides that the fact that benefits under the plan 
may be payable to certain participants before normal retirement age is 
disregarded. Section 411(b)(1)(B)(iv) provides that social security 
benefits and all other relevant factors used to compute benefits are 
treated as remaining constant as of the current plan year for all years 
after the current year.
    Section 411(b)(1)(H)(i) provides that a defined benefit plan fails 
to comply with section 411(b) if, under the plan, an employee's benefit 
accrual is ceased, or the rate of an employee's benefit accrual is 
reduced, because of the attainment of any age. Section 411(b)(5), which 
was added to the Code by section 701(b)(1) of PPA '06, provides 
additional rules related to section 411(b)(1)(H)(i). Section 
411(b)(5)(A) generally provides that a plan is not treated as failing 
to meet the requirements of section 411(b)(1)(H)(i) if a participant's 
accrued benefit, as determined as of any date under the terms of the 
plan, would be equal to or greater than that of any similarly situated, 
younger individual who is or could be a participant. For this purpose, 
section 411(b)(5)(A)(iv) provides that the accrued benefit may, under 
the terms of the plan, be expressed as an annuity payable at normal 
retirement age, the balance of a hypothetical account, or the current 
value of the accumulated percentage of the employee's final average 
compensation. Section 411(b)(5)(G) provides that, for purposes of 
section 411(b)(5), any reference to the accrued benefit of a 
participant refers to the participant's benefit accrued to date.
    Section 411(b)(5)(B) imposes certain requirements on an applicable 
defined benefit plan in order for the plan to satisfy section 
411(b)(1)(H). Section 411(b)(5)(B)(i) provides that such a plan is 
treated as failing to meet the requirements of section 411(b)(1)(H) if 
the terms of the plan provide for an interest credit (or an equivalent 
amount) for any plan year at a rate that is greater than a market rate 
of return. Under section 411(b)(5)(B)(i)(I), a plan is not treated as 
having an above-market rate merely because the plan provides for a 
reasonable minimum guaranteed rate of return or for a rate of return 
that is equal to the greater of a fixed or variable rate of return. 
Section 411(b)(5)(B)(i)(II) provides that an applicable defined benefit 
plan is treated as failing to meet the requirements of section 
411(b)(1)(H) unless the plan provides that an interest credit (or an 
equivalent amount) of less than zero can in no event result in the 
account balance or similar amount being less than the aggregate amount 
of contributions credited to the account. Section 411(b)(5)(B)(i)(III) 
authorizes the Secretary of the Treasury to provide by regulation for 
rules governing the calculation of a market rate of return for purposes 
of section 411(b)(5)(B)(i)(I) and for permissible methods of crediting 
interest to the account (including fixed or variable interest rates) 
resulting in effective rates of return meeting the requirements of 
section 411(b)(5)(B)(i)(I).
    Sections 411(b)(5)(B)(ii), 411(b)(5)(B)(iii), and 411(b)(5)(B)(iv) 
contain additional requirements that apply if, after June 29, 2005, an 
applicable plan amendment is adopted. Section 411(b)(5)(B)(v)(I) 
defines an applicable plan amendment as an amendment to a defined 
benefit plan which has the effect of converting the plan to an 
applicable defined benefit plan. Under section 411(b)(5)(B)(ii), if, 
after June 29, 2005, an applicable plan amendment is adopted, the plan 
is treated as failing to meet the requirements of section 411(b)(1)(H) 
unless the requirements of section 411(b)(5)(B)(iii) 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) specifies that, subject to section 411(b)(5)(B)(iv), 
the requirements of section 411(b)(5)(B)(iii) are met with respect to 
any participant if the accrued benefit of the participant under the 
terms of the plan as in effect after the amendment is not 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 411(b)(5)(B)(iv) provides that, for 
purposes of section 411(b)(5)(B)(iii)(I), the plan must credit the 
participant's account or similar amount with the amount of any early 
retirement benefit or retirement-type subsidy for the plan year in 
which the participant retires if, as of such time, the participant has 
met the age, years of service, and other requirements under the plan 
for entitlement to such benefit or subsidy.
    Section 411(b)(5)(B)(v) sets forth certain provisions related to an 
applicable plan amendment. Section 411(b)(5)(B)(v)(II) provides that if 
the benefits under two or more defined benefit plans of an employer are 
coordinated in such a manner as to have the effect of adoption of an 
applicable plan amendment, the plan sponsor is treated as having 
adopted an applicable plan amendment as of the date the coordination 
begins. Section 411(b)(5)(B)(v)(III) directs the Secretary of the 
Treasury to issue regulations to prevent the avoidance of the purposes 
of section 411(b)(5)(B) through the use of two or more plan amendments 
rather than a single amendment.
    Section 411(b)(5)(B)(vi) provides special rules for determining 
benefits upon termination of an applicable defined benefit plan. Under 
section 411(b)(5)(B)(vi)(I), an applicable defined benefit plan is not 
treated as satisfying the requirements of section 411(b)(5)(B)(i) 
(regarding permissible interest crediting rates) unless the plan 
provides that, upon plan termination, if the interest crediting rate 
under the plan is a variable rate, the rate of interest used to 
determine accrued benefits under the plan is equal to the average of 
the rates of interest used under the plan during the 5-year period 
ending on the termination date. In addition, under section 
411(b)(5)(B)(vi)(II), the plan must provide that, upon plan 
termination, the interest rate and mortality table used to determine 
the amount of any benefit under the plan payable in the form of an 
annuity payable at normal retirement age is the rate and table 
specified under the plan for this purpose as of the termination date, 
except that if the interest rate is a variable rate, the rate used is 
the average of the rates used under the plan during the 5-year period 
ending on the termination date.
    Section 411(b)(5)(C) provides that a plan is not treated as failing 
to meet the requirements of section 411(b)(1)(H)(i) solely because the 
plan provides offsets against benefits under the plan to the extent the 
offsets are otherwise allowable in applying the requirements of section 
401(a). Section 411(b)(5)(D) provides that a plan is not treated as 
failing to meet the requirements of section 411(b)(1)(H) solely because 
the

[[Page 64199]]

plan provides a disparity in contributions or benefits with respect to 
which the requirements of section 401(l) (relating to permitted 
disparity for Social Security benefits and related matters) are met.
    Section 411(b)(5)(E) provides that a plan is not treated as failing 
to meet the requirements of section 411(b)(1)(H) solely because the 
plan provides for indexing of accrued benefits under the plan. Under 
section 411(b)(5)(E)(iii), indexing means the periodic adjustment of 
the accrued benefit by means of the application of a recognized 
investment index or methodology. Section 411(b)(5)(E)(ii) requires 
that, except in the case of a variable annuity, the indexing not result 
in a smaller benefit than the accrued benefit determined without regard 
to the indexing.
    Section 701(a) of PPA '06 added provisions to the Employee 
Retirement Income Security Act of 1974, Public Law 93-406 (88 Stat. 829 
(1974)) (ERISA), that are parallel to sections 411(a)(13) and 411(b)(5) 
of the Code. The guidance provided in these regulations with respect to 
sections 411(a)(13) and 411(b)(5) of the Code would also apply for 
purposes of the parallel amendments to ERISA made by section 701(a) of 
PPA '06, and the guidance provided in these regulations with respect to 
section 411(b)(1) of the Code would also apply for purposes of section 
204(b)(1) of ERISA.\1\
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    \1\ Under section 101 of Reorganization Plan No. 4 of 1978 (43 
FR 47713), the Secretary of the Treasury has interpretive 
jurisdiction over the subject matter addressed by these regulations 
for purposes of ERISA, as well as the Code.
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    Section 701(c) of PPA '06 added provisions to the Age 
Discrimination in Employment Act of 1967, Public Law 90-202 (81 Stat. 
602 (1967)), that are parallel to section 411(b)(5) of the Code. 
Executive Order 12067 requires all Federal departments and agencies to 
advise and offer to consult with the Equal Employment Opportunity 
Commission (EEOC) during the development of any proposed rules, 
regulations, policies, procedures, or orders concerning equal 
employment opportunity. The Treasury Department and the IRS have 
consulted with the EEOC prior to the issuance of these regulations.
    Section 701(d) of PPA '06 provides that nothing in the amendments 
made by section 701 should be construed to create an inference 
concerning the treatment of applicable defined benefit plans or 
conversions of plans into applicable defined benefit plans under 
section 411(b)(1)(H), or concerning the determination of whether an 
applicable defined benefit plan fails to meet the requirements of 
section 411(a)(2), 411(c), or 417(e), as in effect before such 
amendments, solely because the present value of the accrued benefit (or 
any portion thereof) of any participant is, under the terms of the 
plan, equal to the amount expressed as the balance of a hypothetical 
account or as an accumulated percentage of the participant's final 
average compensation.
    Section 701(e) of PPA '06 sets forth the effective date provisions 
with respect to amendments made by section 701 of PPA '06. Section 
701(e)(1) specifies that the amendments made by section 701 generally 
apply to periods beginning on or after June 29, 2005. Thus, the age 
discrimination safe harbors under section 411(b)(5)(A) and section 
411(b)(5)(E) are effective for periods beginning on or after June 29, 
2005. Section 701(e)(2) provides that the special present value rules 
of section 411(a)(13)(A) are effective for distributions made after 
August 17, 2006 (the date PPA '06 was enacted).
    Under section 701(e) of PPA `06, the 3-year vesting rule under 
section 411(a)(13)(B) is generally effective for years beginning after 
December 31, 2007, for a plan in existence on June 29, 2005, while, 
pursuant to the amendments made by section 107(c) of WRERA '08, the 
rule is generally effective for plan years ending on or after June 29, 
2005, for a plan not in existence on June 29, 2005. The market rate of 
return limitation under section 411(b)(5)(B)(i) is generally effective 
for years beginning after December 31, 2007, for a plan in existence on 
June 29, 2005, while the limitation is generally effective for periods 
beginning on or after June 29, 2005, for a plan not in existence on 
June 29, 2005. Section 701(e)(4) of PPA '06 contains special effective 
date provisions for collectively bargained plans that modify these 
effective dates.
    Under section 701(e)(5) of PPA '06, as amended by WRERA '08, 
sections 411(b)(5)(B)(ii), (iii), and (iv) apply to a conversion 
amendment that is adopted on or after, and takes effect on or after, 
June 29, 2005.
    Under section 701(e)(6) of PPA '06, as added by WRERA '08, the 3-
year vesting rule under section 411(a)(13)(B) does not apply to a 
participant who does not have an hour of service after the date the 3-
year vesting rule would otherwise be effective.
    Section 702 of PPA '06 provides for regulations to be prescribed by 
August 16, 2007, addressing the application of rules set forth in 
section 701 of PPA '06 where the conversion of a defined benefit 
pension plan into an applicable defined benefit plan is made with 
respect to a group of employees who become employees by reason of a 
merger, acquisition, or similar transaction.
    Under section 1107 of PPA '06, a plan sponsor is permitted to delay 
adopting a plan amendment pursuant to statutory provisions under PPA 
'06 (or pursuant to any regulation issued under PPA '06) until the last 
day of the first plan year beginning on or after January 1, 2009 
(January 1, 2011, in the case of governmental plans). As described in 
Rev. Proc. 2007-44 (2007-28 IRB 54), this amendment deadline applies to 
both interim and discretionary amendments that are made pursuant to PPA 
'06 statutory provisions or any regulation issued under PPA `06. See 
Sec.  601.601(d)(2)(ii)(b).
    Section 1107 of PPA '06 also permits certain amendments to reduce 
or eliminate section 411(d)(6) protected benefits. Except to the extent 
permitted under section 1107 of PPA '06 (or under another statutory 
provision, including section 411(d)(6) and Sec. Sec.  1.411(d)-3 and 
1.411(d)-4), section 411(d)(6) prohibits a plan amendment that 
decreases a participant's accrued benefits or that has the effect of 
eliminating or reducing an early retirement benefit or retirement-type 
subsidy, or eliminating an optional form of benefit, with respect to 
benefits attributable to service before the amendment. However, an 
amendment that eliminates or decreases benefits that have not yet 
accrued does not violate section 411(d)(6), provided that the amendment 
is adopted and effective before the benefits accrue. If section 1107 of 
PPA '06 applies to an amendment of a plan, section 1107 provides that 
the plan does not fail to meet the requirements of section 411(d)(6) by 
reason of such amendment, except as provided by the Secretary of the 
Treasury.
    Section 1.411(b)-1(a)(1) of the Treasury Regulations provides that 
a defined benefit plan is not a qualified plan unless the method 
provided by the plan for determining accrued benefits satisfies at 
least one of the alternative methods in Sec.  1.411(b)-1(b) for 
determining accrued benefits with respect to all active participants 
under the plan. Section 1.411(b)-1(b)(2)(i) provides that a defined 
benefit plan satisfies the 133\1/3\ percent rule of section 
411(b)(1)(B) for a particular plan year if (A) under the plan the 
accrued benefit payable at the normal retirement age (determined under 
the plan) is equal to the normal retirement benefit (determined under 
the plan), and (B) the annual rate at which any individual who is or 
could be a participant can

[[Page 64200]]

accrue the retirement benefits payable at normal retirement age under 
the plan for any later plan year cannot be more than 133\1/3\ percent 
of the annual rate at which the participant can accrue benefits for any 
plan year beginning on or after such particular plan year and before 
such later plan year. Section 1.411(b)-1(b)(2)(ii)(A) through (D) sets 
forth a series of rules that correspond to the rules of section 
411(b)(1)(B)(i) through (iv). Section 1.411(b)-1(b)(2)(ii)(D) provides 
that, for purposes of the 133\1/3\ percent rule, for any plan year, 
social security benefits and all relevant factors used to compute 
benefits, e.g., consumer price index, are treated as remaining constant 
as of the beginning of the current plan year for all subsequent plan 
years.
    Proposed regulations (EE-184-86) under sections 411(b)(1)(H) and 
411(b)(2) were published by the Treasury Department and the IRS in the 
Federal Register on April 11, 1988 (53 FR 11876), as part of a package 
of regulations that also included proposed regulations under sections 
410(a), 411(a)(2), 411(a)(8), and 411(c) (relating to the maximum age 
for participation, vesting, normal retirement age, and actuarial 
adjustments after normal retirement age, respectively).\2\
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    \2\ On December 11, 2002, the Treasury Department and the IRS 
issued proposed regulations regarding the age discrimination 
requirements of section 411(b)(1)(H) that specifically addressed 
cash balance plans as part of a package of regulations that also 
addressed section 401(a)(4) nondiscrimination cross-testing rules 
applicable to cash balance plans (67 FR 76123). The 2002 proposed 
regulations were intended to replace the 1988 proposed regulations. 
In Ann. 2003-22 (2003-1 CB 847), see Sec.  601.601(d)(2)(ii)(b), the 
Treasury Department and the IRS announced the withdrawal of the 2002 
proposed regulations under section 401(a)(4), and in Ann. 2004-57 
(2004-2 CB 15), see Sec.  601.601(d)(2)(ii)(b), the Treasury 
Department and the IRS announced the withdrawal of the 2002 proposed 
regulations relating to age discrimination.
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    Notice 96-8 (1996-1 CB 359), see Sec.  601.601(d)(2)(ii)(b), 
described the application of sections 411 and 417(e)(3) to a single-sum 
distribution under a cash balance plan where interest credits under the 
plan are frontloaded (that is, where future interest credits to an 
employee's hypothetical account balance are not conditioned upon future 
service and thus accrue at the same time that the benefits attributable 
to a hypothetical allocation to the account accrue). Under the analysis 
set forth in Notice 96-8, in order to comply with sections 411(a) and 
417(e)(3) in calculating the amount of a single-sum distribution under 
a cash balance plan, the balance of an employee's hypothetical account 
must be projected to normal retirement age and converted to an annuity 
under the terms of the plan, and then the employee must be paid at 
least the present value of the projected annuity, determined in 
accordance with section 417(e). Under that analysis, where a cash 
balance plan provides frontloaded interest credits using an interest 
rate that is higher than the section 417(e) applicable interest rate, 
payment of a single-sum distribution equal to the current hypothetical 
account balance as a complete distribution of the employee's accrued 
benefit may result in a violation of the minimum present value 
requirements of section 417(e) or a forfeiture in violation of section 
411(a). In addition, Notice 96-8 proposed a safe harbor which provided 
that, if frontloaded interest credits are provided under a plan at a 
rate no greater than the sum of identified standard indices and 
associated margins, no violation of section 411(a) or 417(e) would 
result if the employee's entire accrued benefit were to be distributed 
in the form of a single-sum distribution equal to the employee's 
hypothetical account balance, provided the plan uses appropriate 
annuity conversion factors. Since the issuance of Notice 96-8, four 
Federal appellate courts have followed the analysis set out in the 
Notice: Esden v. Bank of Boston, 229 F.3d 154 (2d Cir. 2000), cert. 
dismissed, 531 U.S. 1061 (2001); West v. AK Steel Corp. Ret. 
Accumulation Pension Plan, 484 F.3d 395 (6th Cir. 2007), cert. denied, 
129 S. Ct. 895 (2009); Berger v. Xerox Corp. Ret. Income Guarantee 
Plan, 338 F.3d 755 (7th Cir. 2003), reh'g and reh'g en banc denied, No. 
02-3674, 2003 U.S. App. LEXIS 19374 (7th Cir. Sept. 15, 2003); Lyons v. 
Georgia-Pacific Salaried Employees Ret. Plan, 221 F.3d 1235 (11th Cir. 
2000), cert. denied, 532 U.S. 967 (2001).
    Notice 2007-6 (2007-1 CB 272), see Sec.  601.601(d)(2)(ii)(b), 
provides transitional guidance with respect to certain requirements of 
sections 411(a)(13) and 411(b)(5) and section 701(b) of PPA '06. Notice 
2007-6 includes certain special definitions, including: accumulated 
benefit, which is defined as a participant's benefit accrued to date 
under a plan; lump sum-based plan, which is defined as a defined 
benefit plan under the terms of which the accumulated benefit of a 
participant is 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; 
and statutory hybrid plan, which is defined as a lump sum-based plan or 
a plan which has an effect similar to a lump sum-based plan. Notice 
2007-6 provides guidance on a number of issues, including a rule under 
which a plan that provides for indexed benefits described in section 
411(b)(5)(E) is a statutory hybrid plan (because it has an effect 
similar to a lump sum-based plan), unless the plan either solely 
provides for post-retirement adjustment of the amounts payable to a 
participant or is a variable annuity plan under which the assumed 
interest rate used to determine adjustments is at least 5 percent. 
Notice 2007-6 provides a safe harbor for applying the rules set forth 
in section 701 of PPA '06 where the conversion of a defined benefit 
pension plan into an applicable defined benefit plan is made with 
respect to a group of employees who become employees by reason of a 
merger, acquisition, or similar transaction. This transitional 
guidance, along with the other guidance provided in Part III of Notice 
2007-6, applies pending the issuance of further guidance and, thus, 
does not apply for periods to which the 2010 final regulations (as 
described later in this preamble) apply.
    Proposed regulations (REG-104946-07) under sections 411(a)(13) and 
411(b)(5) (2007 proposed regulations) were published by the Treasury 
Department and the IRS in the Federal Register on December 28, 2007 (72 
FR 73680). The Treasury Department and the IRS received written 
comments on the 2007 proposed regulations and a public hearing was held 
on June 6, 2008.
    Proposed regulations (REG-100464-08) under section 411(b)(1)(B) 
(2008 proposed backloading regulations) were published by the Treasury 
Department and the IRS in the Federal Register on June 18, 2008 (73 FR 
34665). The 2008 proposed backloading regulations would provide 
guidance on the application of the accrual rule for defined benefit 
plans under section 411(b)(1)(B) in cases where plan benefits are 
determined on the basis of the greatest of two or more separate 
formulas. The Treasury Department and the IRS received written comments 
on the 2008 proposed backloading regulations and a public hearing was 
held on October 15, 2008.
    Announcement 2009-82 (2009-48 IRB 720) and Notice 2009-97 (2009-52 
IRB 972) announced certain expected relief with respect to the 
requirements of section 411(b)(5). In particular, Announcement 2009-82 
stated that the rules in the regulations specifying permissible market 
rates of return are not expected to go into effect before the first 
plan year that begins on or after January 1, 2011. In addition, Notice

[[Page 64201]]

2009-97 stated that, once final regulations under sections 411(a)(13) 
and 411(b)(5) are issued, it is expected that relief from the 
requirements of section 411(d)(6) will be granted for a plan amendment 
that eliminates or reduces a section 411(d)(6) protected benefit, 
provided that the amendment is adopted by the last day of the first 
plan year that begins on or after January 1, 2010, and the elimination 
or reduction is made only to the extent necessary to enable the plan to 
meet the requirements of section 411(b)(5).\3\ Notice 2009-97 also 
extended the deadline for amending cash balance and other applicable 
defined benefit plans, within the meaning of section 411(a)(13)(C), to 
meet the requirements of section 411(a)(13) (other than section 
411(a)(13)(A)) and section 411(b)(5), relating to vesting and other 
special rules applicable to these plans. Under Notice 2009-97, the 
deadline for these amendments is the last day of the first plan year 
that begins on or after January 1, 2010.
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    \3\ However, see footnote 6 in Section IV.C of this preamble.
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    Final regulations (2010 final regulations) under sections 
411(a)(13) and 411(b)(5) are being issued at the same time as these 
proposed regulations. The 2010 final regulations adopt most of the 
provisions of the 2007 proposed regulations, with certain 
modifications, and also reserve a number of sections relating to issues 
that are not addressed in those final regulations. These reserved 
issues relate to the scope of relief provided under section 
411(a)(13)(A), a potential alternative method of satisfying the 
conversion protection requirements, additional rules with respect to 
the market rate of return requirement, and the application of the 
special plan termination rules. These proposed regulations generally 
address these issues, as well as an issue under section 411(b)(1).

Explanation of Provisions

Overview

    In general, these proposed regulations would provide guidance with 
respect to certain issues under sections 411(a)(13) and 411(b)(5) that 
are not addressed in the 2010 final regulations, as well as an issue 
under section 411(b)(1) for hybrid defined benefit plans that adjust 
benefits using a variable rate.

I. Section 411(a)(13): Scope of Relief of Section 411(a)(13)(A)

A. The 2010 Final Regulations

    The 2010 final regulations define a lump sum-based benefit formula 
as a benefit formula used to determine all or any part of a 
participant's accumulated benefit under which the accumulated benefit 
provided under the formula is expressed as the current balance of a 
hypothetical account maintained for the participant or as the current 
value of an accumulated percentage of the participant's final average 
compensation. The 2010 final regulations provide that the relief of 
section 411(a)(13)(A) applies to the benefits determined under a lump 
sum-based benefit formula.

B. Limitations on the Relief of Section 411(a)(13)(A)

    The proposed regulations would provide that the relief of section 
411(a)(13)(A) does not apply with respect to the benefits determined 
under a lump sum-based benefit formula unless certain requirements are 
satisfied. In particular, the proposed regulations would provide that 
the relief does not apply unless, at all times on or before normal 
retirement age, the then-current hypothetical account balance or the 
then-current accumulated percentage of the participant's final average 
compensation is not less than the present value, determined using 
reasonable actuarial assumptions, of the portion of the participant's 
accrued benefit that is determined under the lump sum-based benefit 
formula. However, the plan would be deemed to satisfy this requirement 
for periods before normal retirement age if, upon attainment of normal 
retirement age, the then-current balance of the hypothetical account or 
the then-current value of the accumulated percentage of the 
participant's final average compensation is actuarially equivalent 
(using reasonable actuarial assumptions) to the portion of the 
participant's accrued benefit that is determined under the lump sum-
based benefit formula. Thus, for periods before normal retirement age, 
a statutory hybrid plan with a lump sum-based benefit formula that 
meets the requirements of the preceding sentence need not project 
interest credits to normal retirement age and discount the resulting 
accrued benefit back in order to apply the relief of section 
411(a)(13)(A) with respect to the benefit determined under the lump 
sum-based benefit formula.
    In addition, the proposed regulations would provide that the relief 
of section 411(a)(13)(A) does not apply unless, as of each annuity 
starting date after normal retirement age, the then-current balance of 
the hypothetical account or the then-current value of the accumulated 
percentage of the participant's final average compensation satisfies 
the requirements of section 411(a)(2) or would satisfy those 
requirements but for the fact that the plan suspends benefits in 
accordance with section 411(a)(3)(B). Thus, for example, a plan that 
expresses the accumulated benefit as the balance of a hypothetical 
account and that does not comply with the suspension of benefit rules 
may have difficulty obtaining the relief of section 411(a)(13)(A) if, 
after normal retirement age, the plan credits interest at such a low 
rate that the adjustments provided by the interest credits, together 
with any principal credits, are insufficient to provide any required 
actuarial increases.
    The proposed regulations would also provide that the relief of 
section 411(a)(13)(A) does not apply unless the balance of the 
hypothetical account or the accumulated percentage of the participant's 
final average compensation may not be reduced except as a result of one 
of the specified reasons set forth in the regulations. Under the 
proposed regulations, reductions would only be permissible as a result 
of: (1) Benefit payments, (2) qualified domestic relations orders under 
section 414(p), (3) forfeitures that are permitted under section 411(a) 
(such as charges for providing a qualified preretirement survivor 
annuity), (4) amendments that are permitted under section 411(d)(6), 
and (5) adjustments resulting from the application of interest credits 
(under the rules of Sec.  1.411(b)(5)-1) that are negative for a 
period, for plans that express the accumulated benefit as the balance 
of a hypothetical account.

C. Application of Section 411(A)(13)(A) to Distributions Other Than 
Single Sums

    The proposed regulations would provide that the relief under 
section 411(a)(13)(A) (with respect to the requirements of sections 
411(a)(2), 411(c), and 417(e)) extends to certain other forms of 
benefit under a lump sum-based benefit formula, in addition to a 
single-sum payment of the entire benefit. In particular, the proposed 
regulations would clarify that the relief provided under section 
411(a)(13)(A) extends to an optional form of benefit that is currently 
payable with respect to a lump sum-based benefit formula if, under the 
terms of the plan, the optional form of benefit is determined as of the 
annuity starting date as the actuarial equivalent, determined using 
reasonable actuarial assumptions, of the then-

[[Page 64202]]

current balance of the hypothetical account or the then-current value 
of an accumulated percentage of the participant's final average 
compensation.
    In addition, the proposed regulations would create a special rule 
that provides that the relief under section 411(a)(13)(A) also extends 
to an optional form of benefit that is not subject to the minimum 
present value requirements of section 417(e) and that is currently 
payable with respect to a lump sum-based benefit formula if, under the 
terms of the plan, this optional form of benefit is determined as of 
the annuity starting date as the actuarial equivalent (using reasonable 
actuarial assumptions) of the optional form of benefit that: (1) 
Commences as of the same annuity starting date; (2) is payable in the 
same generalized optional form (within the meaning of Sec.  1.411(d)-
3(g)(8)) as the accrued benefit; and (3) is the actuarial equivalent 
(using reasonable actuarial assumptions) of the then-current balance of 
the hypothetical account maintained for the participant or the then-
current value of an accumulated percentage of the participant's final 
average compensation. This special rule would facilitate the payment of 
an immediate annuity, such as a joint and survivor annuity or life 
annuity with period certain, that is calculated as the actuarial 
equivalent of the form of payment of the accrued benefit under the 
plan, such as an immediately payable straight life annuity.
    Finally, the proposed regulations would provide that the relief 
under section 411(a)(13)(A) applies on a proportionate basis to a 
payment of a portion of the benefit under a lump sum-based benefit 
formula that is not paid in the form of an annuity, such as a payment 
of a specified dollar amount or percentage of the then-current balance 
of a hypothetical account maintained for the participant or then-
current value of an accumulated percentage of the participant's final 
average compensation. Thus, for example, if a plan that expresses the 
participant's entire accumulated benefit as the balance of a 
hypothetical account distributes 40 percent of the participant's then-
current hypothetical account balance, the plan is treated as satisfying 
the requirements of section 411(a) and the minimum present value rules 
of section 417(e) with respect to 40 percent of the participant's then-
current accrued benefit.

D. Application of Section 411(A)(13)(A) to Plans With Multiple Formulas

    The proposed regulations would clarify that the relief provided 
under section 411(a)(13)(A) does not apply to any portion of the 
participant's benefit that is determined under a formula that is not a 
lump sum-based benefit formula. Thus, for example, where the 
participant's accrued benefit equals the greater of the benefit under a 
hypothetical account formula and the benefit under a traditional 
defined benefit formula, a single-sum payment of the participant's 
entire benefit must equal the greater of the then-current balance of 
the hypothetical account and the present value, determined in 
accordance with section 417(e), of the benefit under the traditional 
defined benefit formula. On the other hand, where the plan provides an 
accrued benefit equal to the sum of the benefit under a hypothetical 
account formula plus the excess of the benefit under a traditional 
defined benefit formula over the benefit under the hypothetical account 
formula, a single-sum payment of the participant's entire benefit must 
equal the then-current balance of the hypothetical account plus the 
excess of the present value, determined in accordance with section 
417(e), of the benefit under the traditional defined benefit formula 
over the present value, determined in accordance with section 417(e), 
of the benefit under the hypothetical account formula. See the request 
for comments under the heading ``Comments and Public Hearing'' on the 
issue of determining the present value of a benefit determined, in 
part, based on the benefit under a lump sum-based benefit formula.

E. Application of Section 411(A)(13)(A) to Pension Equity Plans

    The preamble to the 2007 proposed regulations asked for comments on 
plan formulas that calculate benefits as the current value of an 
accumulated percentage of the participant's final average compensation 
(often referred to as ``pension equity plans'' or ``PEPs''). Commenters 
indicated that some of these plans never credit interest, directly or 
indirectly, some explicitly credit interest after cessation of PEP 
accruals, and some do not credit interest explicitly but provide for 
specific amounts to be payable after cessation of PEP accruals (both 
immediately and at future dates) based on actuarial equivalence using 
specified actuarial factors applied upon cessation of PEP accruals.
    The 2010 final regulations clarify that a formula is expressed as 
the balance of a hypothetical account maintained for the participant if 
it is expressed as a current single-sum dollar amount. Thus, a PEP 
formula that credits interest after cessation of PEP accruals is 
considered a formula that is expressed as the balance of a hypothetical 
account after cessation of PEP accruals. As a result, such a formula is 
a lump sum-based benefit formula that is subject to the rules of 
section 411(a)(13)(A) set forth earlier in this preamble, as those 
rules are applied to PEP formulas during the period of PEP accruals and 
as those rules are applied to hypothetical account balance formulas 
after cessation of PEP accruals.
    Under these proposed regulations, any other PEP formula (including 
those that do not credit interest, directly or indirectly, and those 
that offer actuarially equivalent forms of payment using specified 
actuarial factors applied after cessation of PEP accruals) would also 
be subject to the rules of section 411(a)(13)(A), as explained earlier 
in this preamble. Thus, for example, a PEP that does not explicitly 
credit interest but, instead, calculates the annuity benefit commencing 
at future ages as the actuarial equivalent of the PEP value as of 
cessation of PEP accruals would be eligible for the relief of section 
411(a)(13)(A) with respect to the PEP value as of every period before 
cessation of PEP accruals. In addition, since the accrued benefit is 
calculated as an annuity commencing at normal retirement age that is 
actuarially equivalent to the PEP value as of cessation of PEP 
accruals, the relief described above that applies to annuities that are 
calculated as the actuarial equivalent of the then-current PEP value 
would not apply.

II. Section 411(b)(1): Special Rule With Respect to Statutory Hybrid 
Plans

    Under the regulations with respect to the 133\1/3\ percent rule of 
section 411(b)(1)(B), for any plan year, social security benefits and 
all relevant factors used to compute benefits, e.g., consumer price 
index, are treated as remaining constant as of the beginning of the 
current plan year for all subsequent plan years. A number of commenters 
on both the 2007 proposed regulations and the 2008 proposed backloading 
regulations expressed concern that this rule might effectively preclude 
statutory hybrid plans from using an interest crediting rate that is a 
variable rate that could potentially be negative in a year, such as an 
equity-based rate. This is because, if a plan treated an interest 
crediting rate that was negative as remaining constant in all future 
years for purposes of the backloading test of section 411(b)(1)(B), a 
principal credit (such as a pay credit) that accrues in a later year 
would result in a greater benefit accrual than an otherwise identical 
principal credit that accrues in an earlier year

[[Page 64203]]

because the principal credit that accrues later is credited with 
negative interest credits for fewer years. Thus, these commenters were 
concerned that a plan that uses a variable rate could fail the 
backloading rules of section 411(b)(1) even where both the pay 
crediting and interest crediting formulas do not vary over time.
    In response to these comments, the proposed regulations contain a 
special rule regarding the application of the 133\1/3\; percent rule of 
section 411(b)(1)(B) to a statutory hybrid plan that adjusts benefits 
using a variable interest crediting rate that can potentially be 
negative in any given year. Under this proposed rule, a plan that 
determines any portion of the participant's accrued benefit pursuant to 
a statutory hybrid benefit formula (as defined in Sec.  1.411(a)(13)-
1(d)(4)) that utilizes an interest crediting rate described in Sec.  
1.411(b)(5)-1(d) that is a variable rate that was less than zero for 
the prior plan year would not be treated as failing to satisfy the 
requirements of the 133\1/3\ percent rule for the current plan year 
merely because the section 411(b)(1)(B) backloading calculation is 
performed assuming that the variable rate is zero for the current plan 
year and all future plan years.

III. Section 411(b)(5): Special Conversion Protection Rule and 
Additional Rules With Respect to the Market Rate of Return Limitation

A. Comparison at Effective Date of Conversion Amendment

    In accordance with the requirements of section 411(b)(5)(B)(ii), 
the 2010 final regulations provide that a participant whose benefits 
are affected by a conversion amendment generally must be provided with 
a benefit after the conversion that is at least equal to the sum of 
benefits accrued through the date of conversion and benefits earned 
after the conversion, with no permitted interaction between the two 
portions. The 2010 final regulations provide for an alternative method 
of satisfying the conversion protection requirements where an opening 
hypothetical account balance or opening accumulated percentage of the 
participant's final average compensation is established at the time of 
the conversion and the plan provides for separate calculation of (1) 
the benefit attributable to the opening hypothetical account balance 
(including interest credits attributable thereto) or attributable to 
the opening accumulated percentage of the participant's final average 
compensation and (2) the benefit attributable to post-conversion 
service under the post-conversion benefit formula. Under this 
alternative, the plan must provide that, when a participant commences 
benefits, the participant's benefit will be increased if the benefit 
attributable to the opening hypothetical account or opening accumulated 
percentage that is payable in the particular optional form of benefit 
selected is less than the benefit accrued under the plan prior to the 
date of conversion and that was payable in the same generalized 
optional form of benefit (within the meaning of Sec.  1.411(d)-3(g)(8)) 
at the same annuity starting date.
    The preamble to the 2007 proposed regulations requested comments on 
another alternative method of satisfying the conversion protection 
requirements that would not require this comparison at the annuity 
starting date. In response to favorable comments related to this 
alternative, these proposed regulations would provide that certain 
plans may satisfy the conversion protection requirements of sections 
411(b)(5)(B)(ii), 411(b)(5)(B)(iii), and 411(b)(5)(B)(iv) by 
establishing an opening hypothetical account balance without a 
subsequent comparison of benefits at the annuity starting date. While 
testing at the annuity starting date would not be required under this 
method, a number of requirements like those described in the preamble 
to the 2007 proposed regulations would need to be satisfied in order to 
ensure that the hypothetical account balance used to replicate the pre-
conversion benefit (the opening hypothetical account balance and 
interest credits on that account balance) is reasonably expected in 
most, but not necessarily all, cases to provide a benefit at least as 
large as the pre-conversion benefit for all periods after the 
conversion amendment.
    This alternative method would be limited to situations where an 
opening hypothetical account balance is established and would not be 
available where an opening accumulated percentage of the participant's 
final average compensation is established because these plans would be 
unable to reliably replicate the pre-conversion benefit. This is 
because the value of the opening accumulated percentage would only 
increase as a result of unpredictable increases in compensation for 
periods after the conversion amendment until cessation of PEP accruals, 
rather than by application of an annual interest crediting rate.
    This alternative would only be available where the participant 
elects to receive payment in the form of a single-sum distribution 
equal to the sum of the then-current balance of the hypothetical 
account used to replicate the pre-conversion benefit and the benefit 
attributable to post-conversion service under the post-conversion 
benefit formula. Because of the limited availability of this 
alternative, plans will still need to separately keep track of the pre-
conversion benefit in order to satisfy the conversion protection 
requirements for all forms of distribution other than a single-sum 
distribution. See the related request for comments in this preamble 
under the heading ``Comments and Public Hearing.''
    Under this alternative, in order to satisfy the requirements of 
section 411(d)(6), the participant's benefit after the effective date 
of the conversion amendment must not be less than the participant's 
section 411(d)(6) protected benefit (as defined in Sec.  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 amendment). Also, 
the plan, as in effect immediately before the effective date of the 
conversion amendment, either must not have provided a single-sum 
payment option (for benefits that cannot be immediately distributed 
under section 411(a)(11)) or must have provided a single-sum payment 
option that was based solely on the present value of the benefit 
payable at normal retirement age (or at date of benefit commencement, 
if later) and which was not based on the present value of the benefit 
payable commencing at any date prior to normal retirement age. This 
condition ensures that the hypothetical account balance used to 
replicate the pre-conversion benefit does not result in a single-sum 
distribution that is less than would have been available under an early 
retirement subsidy under the pre-conversion formula.
    Under this alternative method of satisfying the conversion 
protection requirements, the opening hypothetical account balance must 
be established in accordance with the rules under which this opening 
balance is not less than the present value, determined in accordance 
with section 417(e), of the accrued benefit immediately prior to the 
effective date of the conversion amendment. In addition, under this 
alternative, the interest crediting rate under the plan as of the 
effective date of the conversion amendment must be either the rate of 
interest on long-term investment grade corporate bonds (the third 
segment rate) or one of several specified safe harbor rates. Also, as 
of that date, the value of the index used to determine the interest 
crediting rate under the plan must be at least as great

[[Page 64204]]

for every participant or beneficiary as the interest rate that was used 
to determine the opening hypothetical account balance. This requirement 
is satisfied, for example, if each participant's opening hypothetical 
account balance is determined using the applicable interest rate and 
applicable mortality table under section 417(e)(3), the interest 
crediting rate under the plan is the third segment rate, and, at the 
effective date of the conversion amendment, the third segment rate is 
the highest of the three segment rates. If, subsequent to the effective 
date of the conversion amendment, the interest crediting rate changes 
(whether by plan amendment or otherwise) with respect to a participant 
who was a participant at the time of the effective date of the 
conversion amendment from an interest crediting rate that is either the 
rate of interest on long-term investment grade corporate bonds or one 
of the specified safe harbor rates to a different interest crediting 
rate that is not in all cases at least as great as the prior interest 
crediting rate under the plan, then the new interest crediting rate 
does not apply to the existing hypothetical account balance as of the 
effective date of the change in interest crediting rates (or, if the 
plan created a subaccount consisting of the opening hypothetical 
account balance and interest credits on that subaccount, then the new 
interest crediting rate does not apply to the subaccount).
    Finally, either the plan must provide a death benefit after the 
effective date of the conversion amendment which has a present value 
that is at all times at least equal to the then-current balance of the 
hypothetical account used to replicate the pre-conversion benefit or 
the plan must not have applied a pre-retirement mortality decrement in 
establishing the opening hypothetical account balance.

B. Market Rate of Return

    The 2010 final regulations provide that a plan that credits 
interest must specify how the plan determines interest credits and must 
specify how and when interest credits are credited. In addition, the 
2010 final regulations contain certain specific rules regarding the 
method and timing of interest credits, including a requirement that 
interest be credited at least annually.
    The proposed regulations include a rule that would provide that a 
plan is not treated as failing to meet the interest crediting 
requirements merely because the plan does not provide for interest 
credits on amounts distributed prior to the end of the interest 
crediting period. Thus, if a plan credits interest at periodic 
intervals, the plan would not be required to credit interest on amounts 
that were distributed between the dates on which interest under the 
plan is credited to the account balance.
    Furthermore, the proposed regulations include a rule that would 
allow plans to credit interest taking into account increases or 
decreases to the participant's accumulated benefit that occur during 
the period. In particular, the rule would provide that a plan is not 
treated as failing to meet the market rate of return limitations merely 
because the plan calculates increases or decreases to the participant's 
accumulated benefit by applying a rate of interest or rate of return 
(including a rate of increase or decrease under an index) to the 
participant's adjusted accumulated benefit (or portion thereof) for the 
period. For this purpose, the participant's adjusted accumulated 
benefit equals the participant's accumulated benefit as of the 
beginning of the period, adjusted for debits and credits (other than 
interest credits) made to the accumulated benefit prior to the end of 
the interest crediting period, with appropriate weighting for those 
debits and credits based on their timing within the period. For plans 
that calculate increases or decreases to the participant's accumulated 
benefit by applying a rate of interest or rate of return to the 
participant's adjusted accumulated benefit (or portion thereof) for the 
period, interest credits include these increases and decreases, to the 
extent provided under the terms of the plan at the beginning of the 
period and to the extent not conditioned on current service and not 
made on account of imputed service, and the interest crediting rate 
with respect to a participant equals the total amount of interest 
credits for the period divided by the participant's adjusted 
accumulated benefit for the period.
    The proposed regulations would provide that the preservation of 
capital requirement is applied only at an annuity starting date on 
which a distribution of the participant's entire benefit as of that 
date under the plan's statutory hybrid benefit formula commences. The 
proposed regulations would also provide special rules to ensure that 
prior distributions are taken into account in determining the guarantee 
provided by the preservation of capital requirement with respect to a 
current distribution to which the rule applies.
    These proposed regulations would broaden the list of permitted 
interest crediting rates from those permitted under the 2010 final 
regulations. A number of commenters on the 2007 proposed regulations 
requested that the rate of return on plan assets be treated as a market 
rate of return for all types of statutory hybrid plans, and not just 
indexed plans. In response to these comments, the proposed regulations 
would permit the use of the rate of return on plan assets as a market 
rate of return for statutory hybrid plans generally if the plan's 
assets are diversified so as to minimize the volatility of returns. 
Like the 2010 final regulations, the proposed regulations would provide 
that this requirement that plan assets be diversified so as to minimize 
the volatility of returns does not require greater diversification than 
is required under section 404(a)(1)(C) of Title I of the Employee 
Retirement Income Security Act of 1974, Public Law 93-406 (88 Stat. 829 
(1974)) with respect to defined benefit pension plans.
    The preamble to the 2007 proposed regulations asked for comments 
about the possibility of allowing an interest credit to be determined 
by reference to a rate of return on a regulated investment company 
(RIC) described in section 851. The preamble focused on whether such an 
investment has sufficiently constrained volatility that the existence 
of the capital preservation rule would not result in an above market 
rate of return. In response to comments received on the 2007 proposed 
regulations, these proposed regulations would provide that an interest 
crediting rate is not in excess of a market rate of return if it is 
equal to the rate of return on a RIC, as defined in section 851, that 
is reasonably expected to be not significantly more volatile than the 
broad United States equities market or a similarly broad international 
equities market. For example, a RIC that has most of its assets 
invested in securities of issuers (including other RICs) concentrated 
in an industry sector or a country other than the United States, that 
uses leverage, or that has significant investment in derivative 
financial products, for the purpose of achieving returns that amplify 
the returns of an unleveraged investment, generally would not meet this 
requirement. Thus, a RIC that has most of its investments concentrated 
in the semiconductor industry or that uses leverage in order to provide 
a rate of return that is twice the rate of return on the Standard & 
Poor's 500 index (S&P 500) would not meet this requirement. On the 
other hand, a RIC whose investments track the rate of return on the S&P 
500, a broad-based ``small-cap'' index (such as the Russell 2000 
index), or a broad-based international equities index would meet this 
requirement. The requirement that

[[Page 64205]]

the RIC's investments not be concentrated in an industry sector or a 
specific international country is intended to limit the volatility of 
the returns, as well as the risk inherent in non-diversified 
investments. Similarly, the requirement that the RIC not provide 
leveraged returns is intended both to ensure that rates provided by the 
RIC do not exceed an unleveraged market rate as well as to limit the 
volatility of the returns provided. Subject to these requirements, the 
proposed rule is intended to provide plan sponsors with greater 
flexibility in choosing an equity-based rate than would be provided if 
the regulations were to list particular equity-based rates that satisfy 
the market rate of return requirement.
    The preamble to the 2007 proposed regulations requested comments as 
to how to implement a rule that provides that interest credits are 
determined under the greater of two or more interest crediting rates 
without violating the market rate of return limitation. In response to 
such comments, these proposed regulations would provide that in certain 
limited circumstances a plan can provide interest credits based on the 
greater of two or more interest crediting rates without exceeding a 
market rate of return.
    The Treasury Department and the IRS have modeled the historical 
distribution of rates of interest on long-term investment grade 
corporate bonds and have determined that those rates have only 
infrequently been lower than 4 percent and, when lower, were generally 
lower by small amounts and for limited durations. Therefore, the 
increase in the effective rate of return resulting from adding an 
annual 4 percent floor to one of these bond rates has historically been 
small enough that the effective rate of return is not in excess of a 
market rate of return. As a result, the proposed rules would provide 
that it is permissible for a plan to utilize an annual floor of 4 
percent in conjunction with a permissible bond rate. Specifically, the 
proposed regulations would provide that a plan does not provide an 
interest crediting rate that is in excess of a market rate of return 
merely because the plan provides that the interest crediting rate for 
an interest crediting period equals the greater of the rate of interest 
on long-term investment grade corporate bonds (or one of the safe 
harbor rates that, under the regulations, are deemed not to be in 
excess of that rate) and an annual interest rate of 4 percent.
    This rule permitting a plan to utilize an annual floor of 4 percent 
in conjunction with a permissible bond-based rate would also permit 
plans that credit interest more frequently than annually using a 
permissible bond-based rate to also utilize a periodic floor that is a 
pro rata portion of an annual 4 percent floor. Thus, plans that credit 
interest more frequently than annually could provide an effective 
annual floor that is greater than 4 percent, both due to the effect of 
compounding because the floor would be applied more frequently than 
annually and because the floor would be applied in any period that the 
bond-based rate was below the floor, even if the annual rate exceeded 4 
percent for the plan year. However, given the nature of bond-based 
rates, including the serial correlation of rates from one period to the 
next, as well as the fact that 4 percent is not expected to exceed a 
permissible bond-based rate except infrequently, by small amounts, and 
for limited durations, in most instances a periodic floor that is based 
on a 4 percent annual floor will not provide a floor that is 
significantly different than an annual floor of 4 percent.
    In contrast, because of the volatility of equity-based rates, 
adding an annual floor to an equity-based rate often provides a 
cumulative rate of return that far exceeds the rate of return provided 
by the equity-based rate without such floor. It should also be noted 
that commenters on the 2007 proposed regulations generally did not 
request that such an annual floor be permitted (perhaps in recognition 
that a minimum guaranteed annual return when applied to equity-based 
rates could have a significant impact on funding). Accordingly, the 
proposed regulations would not allow the use of an annual floor in 
conjunction with the rate of return on plan assets or on a permissible 
RIC.
    On the other hand, if, instead of applying a floor on each year's