MODIFICATIONS TO THE SENATE FINANCE COMMITTEE 

CHAIRMAN’S MARK OF THE 

“NATIONAL EMPLOYEE SAVINGS AND TRUST EQUITY 

GUARANTEE ACT OF 2005”1

A. Modifications to Provisions in the Chairman’s Mark 

1. Modifications to minimum funding rules for single-employer defined benefit pension 

plans (item III.A.)2

Special rules for plans maintained by financially-weak employers

Under the modification, a plan would not be subject to the special rules for plans 

maintained by financially-weak employers for a year if, as of the valuation date for the year, the 

value of plan assets is at least equal to the applicable percentage of the plan’s target liability 

(determined without regard to the at-risk assumptions). The applicable percent of target liability 

follows the phase-in of the funding rules contained in the Chairman’s Mark, and is 93 percent for 

2007, 96 percent for 2008, and 100 percent for 2009 and thereafter. 

The modification provides that the rules for plans of financially-weak employers do not 

apply to a multiple employer plan if substantially all of the employers participating in the plan 

are rural electric or telephone cooperatives (as defined in clauses (i), (ii), (iii), and (iv) of Code 

section 401(k)(7)(B)) or are cooperative organizations defined in Code section 1381(a) which are 

owned more than 50 percent by agricultural producers or by cooperatives owned by agricultural 

producers. 

 

1 For a description of the Chairman’s mark, see Joint Committee on Taxation, Description of the 

Chairman’s Mark of the “National Employee Savings and Trust Equity Guarantee Act of 2005” (JCX-56-

05), July 22, 2005. 

2 Item numbers refer to provisions in the Chairman’s mark. 

JOINT COMMITTEE ON TAXATION 

July 26, 2005 

JCX-57-05 
2

Special rules for plans maintained by commercial airlines

The modification provides a special funding rule for single employer defined benefit 

plans maintained by commercial passenger airlines. The special funding rule applies if the 

employer elects to have the rule apply and if certain benefit accrual limitations are satisfied. 

Under the special rule, the minimum required funding contribution for a year is the annual 

amount necessary to amortize the unfunded liability of the plan, determined as of the first day of 

the plan year, in equal annual installments over 14 years (or the remainder of the 14-year 

amortization period). The amount of remaining unfunded liability is determined separately for 

each year. An election to have the special funding rule apply may not be revoked without the 

consent of the Secretary. The plan’s interest rate is used under the special rule. Airlines that 

elect the special funding rule could elect to make a one-time change in plan year without 

approval. 

In order for the special rule to apply, the plan generally must provide that accruals are 

frozen under the plan as of the first plan year to which the rule applies. The freeze on accruals 

does not apply to amendments that are required as a condition of qualification of the plan. 

In addition, the special rule does not apply if, at any time after the date of enactment and 

before the first plan year for which the election to apply the rule is made, there is an amendment 

that increases liabilities of the plan due to an increase in benefits, any change in the accrual of 

benefits, or any change in the rate at which benefits become nonforfeitable. Special rules apply 

to ensure that the benefit limitations under the proposal are not avoided in the case of successor 

plans. 

If a plan terminates at a time when the special funding rule applies, then the PBGC 

guarantee provisions are applied as if the plan terminated on the first day of the plan year to 

which the special rule applied. 

These provisions for plans of commercial passenger airlines apply for plan years ending 

after the date of enactment. 

Special rules for a plan maintained by a company engaged primarily in bus service

Under the modification, a special rule applies in the case of a plan that: (1) was not 

required to pay a variable rate premium for the plan year beginning in 1996; (2) has not, in any 

plan year beginning after 1995, merged with another plan (other than a plan sponsored by an 

employer that was within the controlled group of the plan sponsor in 1996); and (3) is sponsored 

by a company that is engaged primarily in the interurban or interstate passenger bus service. 

Under the special rule, the minimum funding rules under the proposal are applied by using the 

mortality tables currently used by the plan. In addition, in determining the minimum required 

contribution for the plan, the value of plan assets is not reduced by the prefunding balance if, 

pursuant to a written agreement with the PBGC, the prefunding balance is not available to reduce 

the minimum required contribution for the plan year. 
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2. Benefit limitations under single-employer defined benefit pension plans (item III.B.) 

The modification eliminates the provision in the Chairman’s mark that provides that 

accruals are frozen when a plan sponsor enters bankruptcy. Thus, under the modification, plans 

of employers that are in bankruptcy are subject to the same limitations on benefit accruals as 

other plans. (Under a provision in the Chairman’s mark that is retained, the PBGC guarantee is 

frozen when a plan enters bankruptcy.) 

3. Restrictions on funding of nonqualified deferred compensation plan when employer’s 

defined benefit plan is underfunded (item III.F.) 

The provision in the Chairman’s mark is modified by substituting 80 percent for 60 

percent in the definition of restricted period. That is, under the modification, in the case of a 

financially-weak employer, a restricted period occurs if the funded target liability percentage of 

the plan is 80 percent or less. 

B. Additional Provisions 

1. Rules relating to cash balance and other hybrid plans 

Present Law

Cash balance and other hybrid plans

A cash balance plan is a defined benefit pension plan with benefits resembling the 

benefits associated with defined contribution plans. Cash balance plans are sometimes referred 

to as “hybrid” plans because they combine features of a defined benefit pension plan and a 

defined contribution plan. Other types of hybrid plans exist as well, such as so-called “pension 

equity” plans. 

Under a cash balance plan, benefits are determined by reference to a hypothetical account 

balance. An employee’s hypothetical account balance is determined by reference to hypothetical 

annual allocations to the account (“pay credits”) (e.g., a certain percentage of the employee’s 

compensation for the year) and hypothetical earnings on the account (“interest credits”). 

Cash balance plans are generally designed so that, when a participant receives a pay 

credit for a year of service, the participant also receives the right to future interest on the pay 

credit, regardless of whether the participant continues employment (referred to as “front-loaded” 

interest credits). That is, the participant’s hypothetical account continues to be credited with 

interest after the participant stops working for the employer. As a result, if an employee 

terminates employment and defers distribution to a later date, interest credits will continue to be 

credited to that employee’s hypothetical account. 

Cash balance plans and other hybrid plans are subject to the qualification requirements 

applicable to defined benefit pension plans generally. However, because such plans have 

features of both defined benefit pension plans and defined contributions plans, questions arise as 
4

to the proper application of the qualification requirements to such plans.3

 Issues that commonly 

arise include: (1) the application of the age discrimination rules; (2) the proper method for 

determining lump-sum distributions; and (3) the treatment of a conversion to a cash balance plan 

or other hybrid plan formula. 

Age discrimination

Present law prohibits any reduction in the rate of a participant’s benefit accrual (or the 

cessation of accruals) under a defined benefit pension plan because of the attainment of any age. 

The age discrimination rules do not prohibit all benefit formulas under which a reduction in 

accruals is correlated with participants’ age in some manner. For example, a plan may limit the 

total amount of benefits, or may limit the years of service or participation considered in 

determining benefits. 

An age discrimination issue has arisen as a result of front-loaded interest credits under 

cash balance plans because there is a longer time for interest credits to accrue on hypothetical 

contributions to the account of a younger participant. Several court cases have considered 

whether front-loaded interest credits under cash balance plans violate the age discrimination 

rules and have reached inconsistent conclusions.4

 A similar issue may arise with respect to other 

types of hybrid plans. 

Calculating minimum lump-sum distributions

Defined benefit pension plans, including cash balance plans and other hybrid plans, are 

required to provide benefits in the form of a life annuity commencing at a participant’s normal 

retirement age. If the plan permits benefits to be paid in certain other forms, such as a lump-sum 

distribution, the alternative form of benefit cannot be less than the present value of the life 

annuity payable at normal retirement age, determined using certain statutorily prescribed interest 

and mortality assumptions. 

Most cash balance plans are designed to permit lump-sum distributions of the 

participant’s hypothetical account balance upon termination of employment. As is the case with 

defined benefit pension plans generally, such a lump-sum amount is required to be the actuarial 

equivalent to the annuity payable at normal retirement age, determined using the statutory 

interest and mortality assumptions. A participant's normal retirement benefit under a cash 

 3

 There is little guidance under present law with respect to many of the issues raised by cash 

balance conversions. In 1999, the IRS imposed a moratorium on determination letters for cash balance 

conversions pending clarification of applicable legal requirements. Under the moratorium, all 

determination letter requests regarding converted cash balance plans are sent to the National Office for 

review; however, the National Office is not currently acting on these plans. 

4

 Tootle v. ARINC Inc., 2004 U.S. Dist. LEXIS 10629 (June 10, 2004); Cooper v. IBM Personal 

Pension Plan, 274 F. Supp. 2d 1010 (S.D. Ill. 2003); Eaton v. Onan, 117 F. Supp. 2d 812 (S.D. Ind. 

2000). In addition, proposed Treasury regulations issued in December 2002 provided rules under which 

cash balance plans could provide front-loaded interest credits without violating the age discrimination 

rules. However, the Treasury Department announced the withdrawal of the regulations in June 2004. 
5

balance plan is determined by projecting the participant’s hypothetical account balance to normal 

retirement age by crediting future interest credits, the right to which has already accrued, and 

converting the projected account balance to an actuarially equivalent life annuity payable at 

normal retirement age, using the interest and mortality assumptions specified in the plan. 

A difference in the rate of interest credits provided under the plan, which is used to 

project the account balance forward to normal retirement age, and the statutory rate used to 

determine the lump-sum value (i.e., present value) of the accrued benefit will cause a 

discrepancy between the value of the minimum lump-sum and the employee’s hypothetical 

account balance. In particular, if the plan’s interest crediting rate is higher than the statutory 

interest rate, then the resulting lump-sum amount will be greater than the hypothetical account 

balance.5

Protection of accrued benefits when a plan is amended

In general, an amendment of a qualified retirement plan may not reduce benefits that 

have already accrued (the “anticutback rule”). For this purpose, an amendment is treated as 

reducing accrued benefits if it has the effect of eliminating or reducing an early retirement 

benefit or a retirement-type subsidy or of eliminating an optional form of benefit. Several 

approaches may be used to comply with the anticutback rule, including wearaway and nowearaway approaches. 

Under a wearaway approach, a participant's accrued benefit after a plan amendment is 

determined as the greater of: (1) the participant's accrued benefit before the amendment 

("preamendment" accrued benefit); and (2) the benefit determined by applying the new benefit 

formula to all the participant's years of service, both before and after the amendment. Under a 

wearaway approach, if a participant's preamendment accrued benefit is greater than the benefit 

provided under the new formula, the participant may have a period (a wearaway period) during 

which the participant does not accrue any additional benefits. 

Under a no-wearaway approach, a participant’s benefit after a plan amendment is 

determined as the sum of: (1) the participant's preamendment accrued benefit; and (2) the 

accrued benefit that results from applying the new formula with respect to years of service after 

the plan amendment. Under this approach, participants earn additional benefits under the new 

plan formula immediately. 

In addition to wearaway and no-wearaway approaches, a plan amendment may include a 

grandfather provision under which the benefit formula that applied before the amendment 

continues to apply to the participants in the plan before the amendment if it provides a greater 

benefit than the new formula or under which such participants may choose between the old and 

new formulas. Alternatively, a plan amendment may provide a grandfather provision for older 

and longer-service participants. 

 5

 This result is sometimes referred to as “whipsaw.” 
6

Description of Proposal

In general

The proposal provides rules that apply on a prospective basis to address issues 

surrounding cash balance plans and other similar hybrid plans with respect to: (1) application of 

the prohibition on age discrimination; (2) determination of minimum lump-sum benefits; and (3) 

requirements for conversions to a cash balance plan design. In addition, the proposal includes 

interest credit and vesting requirements that apply to cash balance plans and other similar hybrid 

plans on a prospective basis. 

Age discrimination

Under the proposal, a cash balance plan or other similar hybrid plan does not violate the 

prohibition on age discrimination merely because, for younger employees, front-loaded interest 

credits apply over a longer period than for older employees, provided that the rate of pay credit 

or interest credit under the plan does not decrease because of the participant's attainment of any 

age. 

Lump-sum distributions

Under the proposal, a cash balance plan or other similar hybrid plan may provide that the 

lump-sum benefit payable to a participant is the balance of the participant's hypothetical account 

balance, provided that the plan does not provide for interest credits at a rate that exceeds a 

market rate of return. The Secretary of the Treasury is authorized to issue regulations as to what 

constitutes a market rate of return for this purpose. It is intended that interest credits will not be 

treated as provided at a rate that exceeds a market rate of return merely because a plan provides 

interest credits at a rate required under the proposal as discussed below (i.e., not less than the 

applicable Federal mid-term interest rate). 

Conversions

Under the proposal, if a defined benefit plan is converted to a cash balance plan or other 

similar hybrid plan pursuant to a plan amendment, one of three transition requirements must be 

met: 

1. The plan must not provide for a wearaway approach with respect to accrued benefits 

or any subsidized optional form of benefit (such as a subsidized early retirement 

benefit). In addition, either (1) for at least five years after the conversion, the plan 

provides all participants who were covered by the plan before the conversion with the 

greater of accruals under the old formula or under the new formula; or (2) in the case 

of participants who, at the time of the conversion, were at least age 40 and had 

combined age and service of at least 55 (or such lower age and combined age and 

service as provided under the plan), after the conversion, the plan provides such 

participants with (a) the greater of the benefits determined under the old formula or 

under the new formula or (b) the right to elect either benefits determined under the old 

formula or under the new formula. 
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2. After the conversion, the plan provides all participants who were covered by the plan 

at the time of the conversion with (1) the greater of the benefits determined under the 

old formula or under the new formula or (2) the right to elect either benefits 

determined under the old formula or under the new formula. 

3. The plan provides additional credits or additional opening account balances in 

amounts substantially equivalent to the benefits that would be provided in order to 

satisfy one of the two preceding requirements, as determined under regulations issued 

by the Secretary of Treasury. It is intended that additional amounts necessary to 

satisfy this requirement shall not cause the plan to violate the nondiscrimination rules 

or the limits on benefits, and that contributions required to provide such additional 

amounts are deductible. 

Vesting and interest credit requirements

Under the proposal, a cash balance plan or other similar hybrid plan generally must 

provide interest credits at a rate not less than the applicable Federal mid-term interest rate (i.e., 

the interest rate based on Treasury obligations with a term of more than three and not more than 

nine years). In addition, the Secretary of Treasury is directed to issue regulations that provide 

alternatives to the use of the applicable Federal mid-term interest rate in appropriate 

circumstances.6

Under the proposal, benefits under a cash balance plan or other similar hybrid plan must 

fully vest after three years of service. 

Definition of hybrid plan

Under the proposal, a cash balance is defined as a defined benefit plan under which the 

accrued benefit is based on the balance of a hypothetical account determined by reference to 

annual pay credits and interest credits. In addition, the Secretary of the Treasury is directed to 

define by regulations other similar hybrid plans to which the proposal applies. 

Effective Date

The proposals relating to the age discrimination rules and minimum lump-sum 

distributions are effective July 26, 2005. The proposal relating to conversions is effective for 

conversions made pursuant to a plan amendment adopted and effective after July 26, 2005. In 

addition, in the case of a conversion pursuant to a plan amendment adopted before July 26, 2005, 

but effective after that date, the employer may elect to apply the proposal to the conversion. The 

proposals relating to interest credits and vesting are effective for plan years beginning after 

December 31, 2006. No inference is intended to be drawn from the proposal as to the treatment 

of cash balance plans (and other hybrid plans) or conversions under present law. 

 6

 For example, in the case of pension equity plans, the interest credit requirement may be applied 

on the basis of a fixed rate of return of three percent, which may be reflected in the benefit formula using 

age groupings of up to five years. 
8

2. Defined benefit plans maintained by tribal governments 

Present Law

Under present law, in some cases governmental plans are subject to different rules than 

other qualified plans. For example, governmental plans generally are not subject to the same 

nondiscrimination rules as other plans and the minimum funding rules do not apply to such 

plans. 

Description of Proposal

The proposal provides that, in the case of defined benefit plans, the term “governmental 

plan” includes a plan established or maintained for its employees by an Indian tribal government 

(as defined in section 7701(a)(40)), a subdivision of an Indian tribal government (determined in 

accordance with section 7871(d)), an agency instrumentality (or subdivision) of an Indian tribal 

government, or an entity established under Federal, State, or tribal law which is wholly owned or 

controlled by any of the foregoing. No inference is intended that the proposal is not present law 

or that defined contributions plans maintained by an employer described in the proposal are not 

governmental plans. 

Effective Date

The proposal is effective on the date of enactment. 

3. Treatment of plan of certain nonprofit organization as a governmental plan 

Present Law

Under present law, in some cases governmental plans are subject to different rules than 

other qualified plans. For example, governmental plans generally are not subject to the same 

nondiscrimination rules as other plans and the minimum funding rules do not apply to such 

plans. 

Description of Proposal

The modification provides that a defined benefit plan of a nonprofit organization is 

treated as a governmental plan if the organization was: (1) incorporated on September 16, 1998, 

under a State nonprofit corporation statute; and (2) organized for the express purpose of 

supporting the missions and goals of a public corporation which was (a) created by a State statute 

effective on July 1, 1995, (b) is a governmental entity under State law, and (c) is a member of the 

nonprofit corporation. 

Effective Date

The proposal is effective on the date of enactment.