The Setting Every Community Up for Retirement Enhancement (Secure) 2.0 Act made significant changes that affect all clients' retirement income planning strategies. One of the lesser-discussed changes involves defined benefit cash balance plans.
Under prior law, cash balance plans were complicated and difficult to administer because no variability was permitted in the way pay credits were allocated to employees — and it could often be difficult for employers to pass so-called "backloading tests" that were designed to prevent discrimination in favor of employees with longer service records.
Secure 2.0 Act has provided employers interested in cash balance plans with the certainty of designing these plans without fear of disqualification — and offered many small business clients a much more alluring and powerful employee benefit option to attract and retain top talent.
Secure 2.0 Act Changes
Under the Secure 2.0 Act, cash balance plan sponsors are now permitted to assume an interest rate that is "reasonable," as long as the assumed interest rate does not exceed 6%.
Cash balance plans cannot "backload" their credits, so that older employees with longer service records enjoy more significant benefits than employees with fewer years of service. One test requires that the plan's annual pay credit be less than 33.3% of the prior year's pay credit.
Higher interest credits generally make it easier for plans to pass these "backloading tests." The 6% cap is designed to prevent employers from assuming unreasonably high interest rates to pass the backloading test. Under prior law, the tests had to be performed "assuming the current rate" when projecting the employee's cash balance plan benefit at normal retirement age. Under that rule, if the rate in the prior year was low or 0%, many plans could not pass the backloading tests even if their rates were reasonably graded.
The new provision begins in 2023.
