SECURE 2.0 guidance gives more flexibility to cash balance plans 

February 7, 2024

Many cash balance plan sponsors will welcome IRS Notice 2024-2’s guidance on the SECURE 2.0 Act of 2022 (Div. T of Pub. L. No. 117-328) provision for demonstrating compliance with the backloading rules of Internal Revenue Code (IRC) Section 411(b). The provision allows a cash balance plan to use a “reasonable projection” of the plan’s interest-crediting rate of up to 6% for this determination. Plan sponsors with an age- or service-graded schedule of pay credits and a variable interest rate (called “graded variable-rate plans” in this article) can lower costs by reducing or eliminating a fixed minimum interest-crediting rate — without needing to preserve the old rate on the already accrued cash balance account. Anti-cutback relief is also available for sponsors that want to switch from a fixed interest-crediting rate to a variable rate. These changes make it easier for plan sponsors to use pay-credit schedules that better reward older, longer-service employees. In addition, the guidance lets sponsors change the plan’s interest-crediting basis to one based on the plan’s actual investment return, which can better align assets and liabilities. Sponsors can immediately implement these changes, but amendments won’t be due until at least Dec. 31, 2026.

SECURE 2.0 helps graded variable-rate plans pass the IRC’s accrual rules. These rules aim to prevent pension plans from skirting minimum vesting standards by delaying accrual of a disproportionate share of total plan benefits until late in a participant’s career. To demonstrate compliance with the rules, most cash balance plans rely on the 133-1/3% test of IRC Section 411(b)(1)(B), which says that the rate of benefit accrual in any later year can’t exceed 133-1/3% of the rate of benefit accrual in any earlier year. In other words, the rate of accrual in a year can’t be more than one-third higher than the rate in any earlier year.

When performing this test, cash balance plans typically use the value of each year’s pay credits with interest to normal retirement date (NRD) as the rate of benefit accrual. For this purpose, IRS previously required sponsors to use the current year’s interest-crediting rate for all future pay credits. This made providing a steeply graded schedule of pay credits difficult, because in years with a low interest rate, the lower pay credits provided at young ages wouldn’t accumulate enough to support providing a larger credit at an older age. To avoid this problem, even plans with moderately graded schedules often needed to adopt a minimum interest-crediting rate to ensure the design passed the test.

The previous rules especially challenged plans with an interest-crediting rate equal to the rate of return on plan assets. These plans can’t have a minimum annual interest credit. To test these plans for backloading, IRS required projecting benefits using a 0% interest-crediting rate. As a result, pay credits at later ages could be no more than one-third higher than the pay credits at younger ages.

SECURE 2.0 lets graded variable-rate plans test for backloading using a reasonable projection of the interest-crediting rate, not to exceed 6%. This will make it significantly easier for these plans to pass the 133-1/3% test without needing a minimum interest credit. Many plans therefore should be able to provide a more steeply graded schedule of pay credits than the pre-SECURE 2.0 rules would permit.

Under the anti-cutback rules of IRC Section 411(d)(6), plan sponsors ordinarily can eliminate a minimum interest rate only on pay credits awarded after the amendment. The plan must preserve the minimum interest rate for balances accrued through the date of the amendment.

SECURE 2.0 grants anti-cutback relief for amendments made pursuant to the act’s provisions. In Notice 2024-2, IRS acknowledges that this relief effectively eliminates the need for a minimum interest-crediting rate in graded variable-rate plans. The agency says that amendments to remove or reduce those rates fall under SECURE 2.0’s anti-cutback relief in either of the following circumstances:

• The plan is currently providing age- or service-based pay credits, and the amendment removes the minimum interest-crediting rate.
• The amendment implements a schedule of age- or service-based pay credits.

The notice cautions that participants’ accrued benefits may not be reduced. That is, although the old minimum interest rate needn’t be provided going forward on existing balances, plan sponsors may not eliminate those rates retroactively: To the extent that the cash balance as of the amendment date reflects a minimum interest credit awarded before the amendment, that balance — including the previously awarded interest — must be maintained.

The notice doesn’t give employers free rein when eliminating (or reducing) minimum interest rates. Cash balance plans still must generally comply with the market rate of return rules in Treas. Reg. § 1.411(b)(5)-1(d), and anti-cutback relief is available only for certain specified changes:

• Variable rate with floor. If the plan’s interest-crediting rate is the greater of a fixed minimum or one of the market rates permitted under Treas. Reg. §§ 1.411(b)(5)-1(d)(3) and 1.411(b)(5)-1(d)(4), the sponsor can eliminate the fixed minimum. The amendment must keep the underlying market rate unchanged or change it to an investment-based rate (typically, the return on all or a portion of the plan’s investment portfolio). No other changes to the underlying rate — such as to reduce the margin on a government bond yield or to a use government bond of a different maturity — are permitted.
• Fixed interest rate. If the interest-crediting rate is a fixed rate, the sponsor can amend the plan to use any permitted variable rate. However, if the plan’s fixed rate is less than 6% (the maximum currently permitted under IRS rules), the difference between 6% and the plan’s fixed rate defines the maximum reduction that the plan may apply to the new variable rate. Specifically, the amount by which the new variable rate is less than the maximum permitted rate for that type of index can’t exceed the amount by which the old fixed rate fell below 6%. For example, the maximum permissible margin for a rate based on a 12-month Treasury bill is 1.5%. If a plan’s old fixed interest-crediting rate was 5% (1% lower than the maximum rate of 6%), the sponsor amending the plan to use a 12-month Treasury bill index would need to add a margin of at least 0.5% — the maximum for that type of rate (12-month T-bill plus 1.50%), reduced by the 1% difference noted above.

Secure 2.0’s changes to the backloading requirements aimed to expand design opportunities for investment return-based cash balance plans by allowing them to provide pay credits that increase with age and service. (As noted earlier, before SECURE 2.0, these plans could not provide pay credits at later ages more than 1/3 higher than at younger ages.) Notice 2024-2 extends this opportunity to other cash balance plans by letting them switch to this type of design for existing cash balance accounts, which can significantly improve the alignment of plan assets and liabilities

The notice doesn’t address a number of issues, such as what constitutes a reasonable projection of the interest-crediting rate and how sponsors may proceed in situations when cash balance plans don’t clearly satisfy all the requirements for anti-cutback relief. Sponsors looking to change the interest-crediting rate when the relief’s applicability is unclear may want to consult with legal counsel before proceeding with an amendment.

• Reasonable projection of interest-crediting rate. The notice appears to allow any plan that meets the criteria for anti-cutback relief simply to eliminate a fixed minimum interest-crediting rate. However, the notice doesn’t eliminate the statutory backloading requirements, which now require using a reasonable projection of the plan’s interest-crediting rate to show that the pay credit schedule doesn’t increase too rapidly. A plan that previously needed a minimum interest-crediting rate to satisfy the backloading requirements presumably would need a variable interest-crediting rate basis that is reasonably projected to exceed that minimum rate. The notice doesn’t provide any guidance on how to make that determination or whether to reevaluate that reasonable projection as the interest-rate environment changes. For example, if a plan currently requires a minimum interest-crediting rate of 5% to support the pay credit schedule and a reasonable projection of the plan’s underlying variable interest-crediting rate is lower than 5%, the plan may not be able to simply eliminate the minimum rate. Even if 5% currently represents a reasonable projection of the interest-crediting rate, that may not be the case in the future (for example, if interest rates revert to pre-2022 levels). This issue may matter less for plans switching to an investment-based credit, depending on the underlying asset mix.
• Amending a plan to qualify for relief. A plan that currently provides for a flat (ungraded) pay-credit schedule with a variable interest-crediting rate would not have needed a fixed minimum interest credit to pass the backloading requirements. Given this relief, however, the sponsor of such a plan may want to implement a graded pay-credit schedule and simultaneously adopt an investment-based interest credit. However, because the plan doesn’t currently have a fixed minimum interest credit, the plan doesn’t appear to meet the conditions for anti-cutback relief. Could such a plan adopt a graded pay-credit schedule along with a minimum interest-crediting rate to qualify for the relief, and then switch to an investment-based interest credit (eliminating the minimum interest-crediting rate just adopted)?
• Permanency. Could a sponsor with a flat pay-credit schedule amend the plan to provide a graded schedule, subsequently amend the plan to change from a fixed interest-crediting rate to a variable rate and shortly thereafter amend the plan to remove the graded schedule?
• Frozen plans. The notice provides anti-cutback relief only to plans “currently providing for principal credits that increase with a participant’s age or service” or implementing such credits as part of the change. This requirement presumably is meant to restrict the relief to plans that no longer need a minimum interest-crediting rate to pass the accrual rules. Frozen plans do not need to satisfy these tests. But some sponsors of frozen plans might have implemented a minimum interest credit or used a fixed interest rate to satisfy the accrual rules when the plan was still ongoing. Are those plans prohibited from taking advantage of this relief? If so, could the sponsor temporarily unfreeze the plan, change the interest-crediting rate and then refreeze the plan?
• Availability of graded pay credit schedule. The notice is silent on whether a graded pay-credit schedule must apply to all cash balance participants for the plan to qualify for the anti-cutback relief or whether the relief is available to plans with a graded pay credit schedule for only a subset of cash balance participants.

Notice 2024-2 provides an extended deadline of Dec. 31, 2026, for SECURE 2.0 amendments (governmental and certain collectively bargained plans may have later dates). Sponsors making amendments after that date — or sponsors of plans that don’t meet the conditions laid out in the notice — won’t get anti-cutback relief and will have to comply with the normal rules, including preserving the old interest rate on participants’ balances accrued through the date of the amendment.

• Notice 2024-2 (IRS, Dec. 20, 2023)
• Div. T of Pub. L. No. 117-328, the SECURE 2.0 Act of 2022 (Congress, Dec. 29, 202)

• User’s guide to SECURE 2.0 (regularly updated)
• Taking a look at SECURE 2.0’s defined benefit provisions (Feb. 21, 2023)