Congress Opens the Door for the Retirement Program of the Future

As happens late every year, Congress has passed a spending bill, this time called the Consolidated Appropriations Act, 2023 (CAA 2023). As anticipated, the bill includes a wealth of retirement provisions often referred to as SECURE 2.0. Most of the provisions in SECURE 2.0 are 401(k)- or 403(b)-related, as expected. We cover that topic in our article, SECURE 2.0 included in omnibus budget legislation.

We were also greeted with a lame duck surprise in the form of a legislative fix to a highly technical Treasury Regulation dealing with accrual rules for cash balance plans with a variable interest crediting rate. Employers that want to design their retirement programs to be an employer of choice for 2025 and beyond can now do so. They can give their employees and future employees what they are asking for while staying on budget.

We’ll spare you the technical details, however, and focus on why defined benefit plan sponsors, and consequently their employees, should care.

For more than 30 years, sponsors of defined benefit plans have noticed the advantages of cash balance plans as compared to traditional pension plans in many workforces. Perhaps the key element is that employees can understand what is going on. They get a pay credit added to their notional account, the account grows with interest, and they have an account balance. From an HR standpoint, that’s a great design.

Finance executives, however, have been a bit less enamored with cash balance plans. Patterns of required contributions have been difficult to predict, and those required contributions have tended to be largest when the plan sponsor’s ability to contribute has been at its smallest. The key driver of that challenge has been the interest crediting rate. Traditional cash balance plans use a fixed crediting rate, e.g., 5% per year, or a rate tied to returns on some Treasury offerings, e.g., the rate on 30-year Treasuries.

Neither is ideal for plan sponsors or for plan participants. In some years, investment returns in the plan far exceed the promised return on participant accounts, while in other years, they fall far short. This results in significant volatility in required employer contributions.

From a participant standpoint, that fixed rate of return often pales in comparison to what might be achieved in a balanced portfolio of equities and fixed income. And no participant seems to understand why their accounts should only return the same amount as a pool of risk-free investments.

In the Pension Protection Act of 2006, Congress gave us a solution in the form of a market-based cash balance plan. Since PPA, we’ve been able to design plans with interest crediting rates tied to rates that can be achieved on investments actually available in the market. That is, interest crediting rates would be tied to those available on some balanced portfolio.

This accomplishes two very key goals: 1) liabilities and assets can move in tandem, thereby stabilizing required contributions, and 2) interest crediting rates make sense to participants. No other design that we have seen does that.

But many cash balance plans were designed with graded pay credits, e.g., 3% of pay until age 40, 4% of pay from age 40 to 55, and 5% of pay thereafter. That was perfectly legal, but the Treasury Regulations caused problems in market-based cash balance plans.

Now, we have a legislative fix. The statute is clear in allowing those designs that the Regulations didn’t.

What an employer gets from such a design is what they are asking for. This gives Finance the stable and predictable amounts of required contributions they have been looking for. It gives Human Resources a unique workforce management tool. It will assist in retaining a great workforce, give HR tools to facilitate employees in their transition to retirement, and attract great employees today and in the future by giving them what they are asking for that they simply can’t get in other places of employment.

Employees will get an easy to understand defined benefit plan. That gives them an opportunity to get guaranteed lifetime income at an actuarially fair price through an employer-provided plan. In this way, their retirement benefits continue to increase even in years that they are not able to contribute to their 401(k) or 403(b) plans.  Such a program caters to a diverse workforce because it provides great benefits not just in times that employees are able to contribute to their own retirement but also when circumstances are such that they can’t. It’s personalized, and it’s customizable for each employee. That’s what employees are asking for.

It took a legislative fix, but Congress has given employers and their employees a path to the retirement program of the future.