Determining Actuarial Equivalence under Cash Balance Plans

When selecting assumptions for actuarial equivalence before the changes made under the Pension Protection Act of 2006 (PPA), it was not unusual for traditional defined benefit plans to make reference to the Code §417(e) assumptions. With the changes under PPA, referencing Code §417(e) rates for actuarial equivalence can cause difficulty for the plan’s actuary, especially for cash balance plans. Prior to the implementation of the funding rules for defined benefit plans under PPA, Code §417(e) included a fixed mortality table, and only the single interest assumption was changed each year. However, with PPA, the interest rates are segment rates, and the mortality table changes along with these rates each year. The result requires some complex calculations to adjust the equivalent accrued benefit from year to year. The adjusted benefit is used for the purpose of discrimination testing under Code §§401(a)(4), 401(a)(26) and 410(b). Since a method of applying the segment rates and mortality table could result in benefits that differ from what the ultimate IRS regulations would produce, these tests might appear to pass but may ultimately fail under an audit review. As such, we suggest a single interest rate and mortality table be selected for the actuarial equivalence assumptions in a defined benefit plan. Such interest rate may be a variable rate such as the Treasury rate, but it may be best to fix the mortality table in the plan document. To simplify the administration of a cash balance plan, it is suggested the plan use the same interest rate for both actuarial equivalence and the interest crediting rate. In conjunction with the above, it is recommended that the plan use a single interest rate for both the actuarial assumptions and interest crediting rate under the cash balance plan.