On April 7, 2017, the IRS issued a memorandum relating to cash balance retirement plans.  A cash balance plan is a defined benefit pension plan which looks like a defined contribution plan because participants have individual “hypothetical” account balances.  The employer typically credits a flat percentage of compensation to each eligible employee, and the employee’s account balance grows based on specified interest credits. 

The new IRS guidance addresses cash balance plans that calculate benefits using only a portion of annual compensation, a special bonus or pay over a certain threshold rather than annual compensation.  The IRS cautions that cash balance plans which give the employer discretion to determine what compensation is included for benefit contribution purposes may violate the Internal Revenue Code “definitely determinable” requirement that applies to all defined benefit pension plans, including cash balance plans.  The problem arises when the employer has discretion to determine which part of compensation is considered.  The plan terms may specify whether base compensation,  bonuses or specified pay credits are included in the plan benefit formula.  However, if the employer has discretion or the inherent ability to determine how much W-2 compensation is paid in a way that manipulates pay credits or compensation used in the benefit formula, then the plan may violate IRS rules.  Any operational defect would have to be corrected pursuant to IRS correction procedures. 

Cash balance plans are still relatively popular and can be particularly beneficial for certain employers.