Today the Internal Revenue Service (IRS) released long-awaited regulations regarding hybrid plans. The regulations are split into two portions — final regulations that update regulations that were originally proposed back in 2010 and newly proposed regulations.

Final Regulations: The final regulations are effective for plan years beginning on or after January 1, 2016, and primarily address the market-rate-of-return requirement for cash balance plans (i.e., what constitutes a permissible interest crediting rate) and issues related to whipsaw relief. In general, the final regulations modestly expand what is considered to be a permissible interest crediting rate, but retain the closed-group approach under which rates other than those specifically described will be viewed as exceeding a market rate. The regulations increase the maximum permitted fixed interest credit from 5% to 6%, and for some government bond-based rates, increase the permissible annual minimum from 4% to 5%. The final regulations also generally favorably resolve issues surrounding the ability of hybrid plans to provide early retirement and optional-form subsidies. In addition, the final regulations clarify that plans that determine a benefit as a single sum at normal retirement, rather than currently, are not hybrid plans.

Proposed Regulations: The proposed regulations address the transition from a noncompliant interest crediting rate to one that is permitted under the final regulations. An amendment that reduces the interest crediting rate with respect to benefits that have already accrued would ordinarily be an impermissible cutback. Although the rules provide anti-cutback relief, this relief is not as broad as some plan sponsors had hoped. In particular, the IRS declined requests to permit a change from a noncompliant interest crediting rate to any of the maximum-compliant interest crediting rates. In their view, this approach would permit a plan sponsor to reduce the interest crediting rate more than is appropriate. Instead, the general approach in the proposed regulations is to permit amendments that bring the plan into compliance by changing the specific feature that causes the plan's interest crediting rate to be noncompliant, while not changing other features of the existing rate. The proposed regulations are fairly prescriptive for simple rates but are more complex for the combination rates that are common to many hybrid plans.

To qualify for the anti-cutback relief, the proposal requires plan amendments to be adopted prior to and effective no later than the first day of the first plan year that begins on or after January 1, 2016. The IRS also proposes to allow plan sponsors to apply the regulations, as finalized, to plan amendments that are adopted during earlier periods.

Comments are requested on all aspects of the proposed regulations but particularly with respect to appropriate transition amendments for plans that credit interest using an investment-based rate of return with an impermissible minimum rate. Comments on the proposed regulations are due by December 18, 2014, and a public hearing on the regulations is scheduled for January 9, 2015.

Pension Equity Plans (PEPs): Neither the final nor proposed regulations contain substantial guidance on PEPs, though the final regulations do helpfully clarify that a reduction in the accumulated benefit under a PEP formula is permitted to the extent that it results from a decrease in the participant's final average compensation or from an increase in the integration level (in the case of a formula that is integrated with Social Security). The IRS has a separate project regarding these plans on its guidance schedule.

Overall, the regulations are long and complex, and will have varying effects based on specific plan provisions. We will provide more information as we continue to analyze the regulations. Please contact your local Towers Watson consultant to discuss this topic further.