rr-08-07.pdf

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Part I

Section 411. – Minimum Vesting Standards

26 CFR 1.411(b)-1: Accrued benefit requirements.

(Also, § 7805; § 301.7805-1.)

Rev. Rul. 2008-7

ISSUE

Does the defined benefit plan described below that was converted from a
traditional benefit formula to a lump sum-based benefit formula satisfy the
accrual rules of § 411(b)(1)(A), (B), and (C) of the Internal Revenue Code for the
2002 plan year?

FACTS

Plan A is a defined benefit pension plan that (prior to the amendment described
below) provided a normal retirement benefit payable in the form of a straight life
annuity commencing at the age 65 normal retirement age under the plan equal to
the product of 1.1% of average compensation for the three consecutive years of
service with the highest such average multiplied by the number of years of
service at normal retirement age. Under Plan A, the accrued benefit (prior to the
amendment described below) of a participant at any point prior to attainment of
normal retirement age is the benefit, payable in the form of a straight life annuity
commencing at the age 65 normal retirement age, equal to the product of 1.1%
of the participant’s highest average compensation at such point multiplied by the
participant’s number of years of service at such point. Plan A provides that an
employee commences participation in the plan on the first day of the first month
after commencing employment, or, if later, the first day of the first month
following attainment of age 21.

Plan A was amended in 2001 to change the plan’s benefit formula effective for
plan years beginning on or after January 1, 2002. The new benefit formula is a
“lump sum-based” benefit formula as further described below. Under the lump
sum-based benefit formula, a hypothetical account is created for each
participant. For participants who were employees on December 31, 2001, the
opening account balance was equal to the actuarial present value of the
participant’s accrued benefit determined as of that date. Under Plan A, this
actuarial present value was determined using the applicable interest rate, post-

2
retirement mortality using the applicable mortality table specified under
§ 417(e)(3) for 2002, and no pre-retirement mortality. Thereafter, the
hypothetical account balance is credited with hypothetical interest at the rate of
interest on 3-year Treasury Constant Maturities for the month prior to the first day
of the plan year plus 25 basis points (for the 2002 plan year, the rate of interest
was determined as 3.87%, which is 3.62%, the yield on 3-year Treasury
Constant Maturities for December 2001, plus 25 basis points). Additionally, the
hypothetical account for each participant is credited at the end of each accrual
computation period (which is the plan year) with pay credits that are determined
as a percentage of compensation for the participant for the plan year. The
percentage is determined, based upon the age of the participant at the beginning
of the plan year, in accordance with the following table:

Age at Beginning of Year Percentage

25 or less 3
26-40 4
41-50 5
51-60 6
61 or more 7

The annual benefit payable at the age 65 normal retirement age under the new
benefit formula is determined by converting the hypothetical account balance at
that time to a straight life annuity. The plan provides for the conversion to a
straight life annuity to be made using the applicable interest rate and applicable
mortality table, defined as the 30-year Treasury rate as published by the
Commissioner of Internal Revenue under § 417(e)(3) for the month prior to the
beginning of the plan year, and the mortality table published by the
Commissioner under § 417(e)(3). For 2002, that applicable interest rate was
5.48% and that applicable mortality table was the mortality table set forth in
Revenue Ruling 2001-62, 2001-2 C.B. 632.

The amendment to Plan A also changed how the accrued benefit of a participant
is determined under the plan. For participants who were employed on December
31, 2001, had completed 15 years of service, and had attained age 50 as of that
date, Plan A provides that the accrued benefit will be the greater of the accrued
benefit provided by the hypothetical account balance at the age 65 normal
retirement age (determined as described above) and the accrued benefit
determined under the pre-conversion formula as in effect on December 31, 2001,
taking into account compensation and years of service after December 31, 2001,
but not taking into account compensation and years of service after December
31, 2005. Plan A refers to such participants as grandfathered participants. The
accrued benefit provided by the hypothetical account balance at the age 65
normal retirement age is equal to the hypothetical account balance at that age
(including projected interest credits under the plan to age 65), converted to a

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straight life annuity commencing at age 65 using the applicable interest rate and
applicable mortality table.

For participants who were employed on December 31, 2001, and who either had
not completed 15 years of service or had not attained age 50 as of that date (i.e.,
participants who are not grandfathered participants), Plan A provides that the
accrued benefit at any point in time is determined as the greater of (1) the
accrued benefit determined under the terms of the plan under the pre-conversion
formula immediately before the amendment, but taking into account only service
and compensation through December 31, 2001, and (2) the accrued benefit
provided by the hypothetical account balance at the age 65 normal retirement
age (determined as described above). Accordingly, compensation increases and
years of service after December 31, 2001, are not taken into account in
determining the accrued benefit under the pre-conversion formula.

For all new participants (i.e., those employees who commenced participation on
or after January 1, 2002), the accrued benefit at any point is the accrued benefit
provided by the hypothetical account balance at the age 65 normal retirement
age (determined as described above).

LAW

Section 401(a)(7) provides that a trust is not a qualified trust under § 401 unless
the plan of which such trust is a part satisfies the requirements of § 411 (relating
to minimum vesting standards).

Section 411(a) requires a qualified plan to provide that an employee’s right to the
normal retirement benefit is nonforfeitable upon attainment of normal retirement
age and that an employee’s right to his or her accrued benefit is nonforfeitable
upon completion of the specified number of years of service under one of the
vesting schedules set forth in § 411(a)(2). Section 411(a) also requires that a
defined benefit plan satisfy the requirements of § 411(b)(1).

Section 411(a)(7)(A)(i) defines a participant’s accrued benefit under a defined
benefit plan as the employee’s accrued benefit determined under the plan,
expressed in the form of an annual benefit commencing at normal retirement
age, subject to an exception for § 411(c)(3). Under § 411(c)(3), the accrued
benefit is the actuarial equivalent of the annual benefit commencing at normal
retirement age in the case of a plan that does not express the accrued benefit as
an annual benefit commencing at normal retirement age.

Section 1.411(a)-7(a)(1) of the Income Tax Regulations provides that, for
purposes of § 411 and the regulations thereunder, the accrued benefit of a
participant under a defined benefit plan is either (A) the accrued benefit
determined under the plan if the plan provides for an accrued benefit in the form
of an annual benefit commencing at normal retirement age or (B) an annual

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benefit commencing at normal retirement age which is the actuarial equivalent
(determined under § 411(c)(3) and § 1.411(c)-1) of the accrued benefit under the
plan if the plan does not provide for an accrued benefit in the form of an annual
benefit commencing at normal retirement age.

Section 411(b)(1) provides that a defined benefit plan must satisfy one of the
three accrual rules of § 411(b)(1)(A), (B), and (C) with respect to benefits
accruing under the plan. The three accrual rules are the 3% method of
§ 411(b)(1)(A), the 133 1/3% rule of § 411(b)(1)(B), and the fractional rule of
§ 411(b)(1)(C).

Section 411(b)(1)(A) provides that a defined benefit plan satisfies the
requirements of the 3% method if, under the plan, the accrued benefit payable
upon the participant’s separation from service is not less than (A) 3% of the
normal retirement benefit to which the participant would be entitled if the
participant commenced participation at the earliest possible entry age under the
plan and served continuously until the earlier of age 65 and the normal retirement
age under the plan, multiplied by (B) the number of years (not in excess of 33 1/3
years) of his or her participation in the plan. Section 411(b)(1)(A) provides that,
in the case of a plan providing retirement benefits based on compensation during
any period, the normal retirement benefit to which a participant would be entitled
is determined as if the participant continued to earn annually the average rate of
compensation during consecutive years of service, not in excess of 10, for which
his or her compensation was highest. Section 411(b)(1)(A) also provides that
Social Security benefits and all other relevant factors used to compute benefits
are treated as remaining constant as of the current plan year for all years after
the current year.

Section 411(b)(1)(B) provides that a defined benefit plan satisfies the
requirements of the 133 1/3% rule for a particular plan year if, under the plan, the
accrued benefit payable at the normal retirement age is equal to the normal
retirement benefit, and the annual rate at which any individual who is or could be
a participant can accrue the retirement benefits payable at normal retirement age
under the plan for any later plan year is not more than 133 1/3% of the annual
rate at which the individual can accrue benefits for any plan year beginning on or
after such particular plan year and before such later plan year.

For purposes of applying the 133 1/3% rule, § 411(b)(1)(B)(i) provides that any
amendment to the plan which is in effect for the current year is treated as in
effect for all other plan years. Section 411(b)(1)(B)(ii) provides that any change
in an accrual rate which does not apply to any individual who is or could be a
participant in the current plan year is disregarded. Section 411(b)(1)(B)(iii)
provides that the fact that benefits under the plan may be payable to certain
participants before normal retirement age is disregarded. Section
411(b)(1)(B)(iv) provides that Social Security benefits and all other relevant

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factors used to compute benefits are treated as remaining constant as of the
current plan year for all years after the current year.

Section 411(b)(1)(C) provides that a defined benefit plan satisfies the fractional
rule if the accrued benefit to which any participant is entitled upon his or her
separation from service is not less than a fraction of the annual benefit
commencing at normal retirement age to which the participant would be entitled
under the plan as in effect on the date of separation if the participant continued to
earn annually until normal retirement age the same rate of compensation upon
which the normal retirement benefit would be computed under the plan,
determined as if the participant had attained normal retirement age on the date
on which any such determination is made (but taking into account no more than
10 years of service immediately preceding separation from service). The fraction
is a fraction, not exceeding 1, the numerator of which is the total number of the
participant’s years of participation in the plan (as of the date of separation from
service) and the denominator of which is the total number of years the participant
would have participated in the plan if the participant separated from service at
normal retirement age. Section 411(b)(1)(C) also provides that Social Security
benefits and all other relevant factors used to compute benefits are treated as
remaining constant as of the current plan year for all years after the current year.

Section 1.411(b)-1(a)(1) provides that a defined benefit plan is not a qualified
plan unless the method provided by the plan for determining accrued benefits
satisfies at least one of the three alternative methods in § 1.411(b)-1(b) for
determining accrued benefits with respect to all active participants under the
plan. The three alternative methods are the 3% method, the 133 1/3% rule, and
the fractional rule. A defined benefit plan may provide that accrued benefits for
participants are determined under more than one plan formula. Section 1.411(b)-
1(a)(1) provides that, in such a case, the accrued benefits under all such
formulas must be aggregated in order to determine whether or not the accrued
benefits under the plan for participants satisfy one of these methods. Under
§ 1.411(b)-1(a)(1), a plan may satisfy different methods with respect to different
classifications of employees, or separately satisfy one method with respect to the
accrued benefits for each such classification, provided that such classifications
are not so structured as to evade the accrued benefit requirements of § 411(b)
and § 1.411(b)-1.

Section 1.411(b)-1(b)(1)(i) provides that a defined benefit plan satisfies the
requirements of the 3% method for a plan year if, as of the close of the plan year,
the accrued benefit to which each participant is entitled, computed as if the
participant separated from service as of the close of such plan year, is not less
than 3% of the 3% method benefit, multiplied by the number of years (not in
excess of 33 1/3) of his or her participation in the plan, including years after
normal retirement age. The 3% method benefit is the normal retirement benefit
to which the participant would be entitled if the participant commenced
participation at the earliest possible entry age for any individual who is or could

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be a participant under the plan and served continuously until the earlier of age 65
and the normal retirement age under the plan.

Section 1.411(b)-1(b)(2)(i) provides that a defined benefit plan satisfies the
133 1/3% rule for a particular plan year if (A) under the plan the accrued benefit
payable at the normal retirement age (determined under the plan) is equal to the
normal retirement benefit (determined under the plan), and (B) the annual rate at
which any individual who is or could be a participant can accrue the retirement
benefits payable at normal retirement age under the plan for any later plan year
cannot be more than 133 1/3% of the annual rate at which the participant can
accrue benefits for any plan year beginning on or after such particular plan year
and before such later plan year.

Pursuant to § 411(b)(1)(B)(i), § 1.411(b)-1(b)(2)(ii)(A) provides that, for purposes
of the 133 1/3% rule, any amendment to the plan which is in effect for the
current plan year is treated as if it were in effect for all other plan years.
Pursuant to § 411(b)(1)(B)(ii), § 1.411(b)-1(b)(2)(ii)(B) provides that any change
in an accrual rate which change does not apply to any individual who is or could
be a participant in the current plan year is disregarded. The regulations provide
an example illustrating this rule under which, for the plan year 1980, a plan
provides an accrued benefit of 2% of the highest 3 years’ compensation for each
year of service and provides that, for the plan year 1981, the accrued benefit is
3% of the highest 3 years’ compensation. The regulations then state that the
change in rate does not cause the plan to fail to satisfy the 133 1/3% rule
because in the plan year 1980 the change in the accrual rate does not apply to
any individual who is or could be a participant in the plan year 1980. However,
the regulations further state that if, for example, a plan were to provide for an
accrued benefit of 1% of the highest 3 years’ compensation for each of the first
10 years of service and 1.5% of such compensation for each year of service
thereafter, then the plan would fail to satisfy the 133 1/3% rule for the plan year
even though no participant is actually accruing at the 1.5% rate because an
individual who could be a participant and who has over 10 years of service would
accrue at the 1.5% rate, which exceeds 133 1/3% of the 1.0% rate.

Section 1.411(b)-1(b)(2)(ii) provides that the fact that certain benefits under the
plan may be payable to certain participants before normal retirement age is
disregarded. Section 1.411(b)-1(b)(2)(ii) further provides that a plan does not
satisfy the requirements of § 1.411(b)-1(b)(2) if the base for the computation of
retirement benefits changes solely by reason of an increase in the number of
years of participation.

Section 1.411(b)-1(b)(2)(iii) provides examples illustrating the 133 1/3% rule. One
of these examples, Example (3), concludes that a plan fails to satisfy the
133 1/3% rule where the plan provides for an annual benefit commencing at age
65 equal to a percentage of a participant’s highest 3 years of compensation
equal to 2% for each of the first 5 years of participation, 1% for each of the next 5

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years of participation, and 1.5% for each subsequent year of participation (even
though the average rate of accrual in this case is not less rapid than ratable).

Section 1.411(b)-1(b)(3)(i) provides that a defined benefit plan satisfies the
fractional rule if the accrued benefit to which any participant is entitled is not less
than the fractional rule benefit multiplied by a fraction (not exceeding one) (A) the
numerator of which is the participant’s total number of years of participation in the
plan, and (B) the denominator of which is the total number of years the
participant would have participated in the plan if he or she separated from service
at the normal retirement age under the plan.

Section 1.411(b)-1(b)(3)(ii) provides that the “fractional rule benefit” is the annual
benefit commencing at normal retirement age under the plan to which a
participant would be entitled if the participant continued to earn annually until
normal retirement age the same rate of compensation upon which the
participant’s normal retirement benefit would be computed. The rate of
compensation is computed on the basis of compensation taken into account
under the plan (but taking into account average compensation for no more than
the 10 years of service immediately preceding the determination). For purposes
of the fractional rule benefit, the normal retirement benefit is determined as if the
participant had attained normal retirement age on the date any such
determination is made. Section 1.411(b)-1(b)(3)(ii) further provides that, for
purposes of the fractional rule, for any plan year, Social Security benefits and all
relevant factors used to compute benefits, e.g., consumer price index, are treated
as remaining constant as of the beginning of the current plan year for all
subsequent plan years.

Section 1.411(b)-1(b)(3)(iii) provides examples illustrating the fractional rule. One
of these examples, Example (2), concludes that, in the case of a plan that
provides a normal retirement benefit of 1% of average compensation multiplied
by the number of years of plan participation completed by the participant, the
plan fails to satisfy the fractional rule with respect to a participant whose annual
compensation over an 11-year period varies from $17,000 up to $32,000. If the
participant were to separate from service at the end of the period, the
participant’s annual benefit under the plan would be $2,530 commencing at age
65 (based on the 11 years of compensation), which is less than $2,561, which,
taking into account only the last 10 years of compensation, is the minimum
annual benefit under the fractional rule.

Notice 96-8, 1996-1 C.B. 359, states that benefits attributable to interest credits
under a cash balance plan are in the nature of accrued benefits within the
meaning of § 1.411(a)-7(a). Notice 96-8 further states that, in order for a plan’s
interest credits to satisfy the accrual rules of § 411(b)(1), the interest must be
frontloaded. In order for interest to be frontloaded, the benefits attributable to
future interest credits with respect to a hypothetical allocation accrue at the same
time as the benefits attributable to the hypothetical allocation. Thus, in

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determining the accrued benefit of a participant under a cash balance plan at any
time prior to normal retirement age, the balance in the cash balance account
must be projected with interest credits to normal retirement age. (See, however,
§ 411(a)(13), as added by the Pension Protection Act of 2006, Public Law 109-
280 (PPA ’06), for special rules which apply to certain hybrid pension plans for
purposes of the vesting and distribution rules of §§ 411(a)(2), 411(c), and
417(e), but which do not apply for purposes of the benefit accrual rules of
§ 411(b)(1)(A)-(C).)

Notice 2007-6, 2007-3 I.R.B. 272, states that, on September 15, 1999, the
Service’s Director, Employee Plans, issued a field directive (the 1999 Field
Directive) requiring that open determination letter applications and examination
cases that involved the conversion of a defined benefit plan formula into a benefit
formula commonly known as a cash balance formula be submitted for technical
advice with respect to the conversion’s effect on the qualified status of the plan.
Notice 2007-6 further states that in Announcement 2003-1, 2003-1 C.B. 281, the
Service announced that the cases that were the subject of the 1999 Field
Directive would not be processed pending issuance of regulations addressing
age discrimination. Further, Notice 2007-6 states that the Service will resume
processing the determination letter and examination cases that were the subject
of the 1999 Field Directive and Announcement 2003-1. Notice 2007-6 refers to
these plans as “moratorium plans.”

ANALYSIS

A plan satisfies the accrual rules of § 411(b)(1)(A), (B), and (C) if, for all
participants, the accrued benefit of each participant satisfies one of the three
alternative methods (the 3% method, the 133 1/3% rule, or the fractional rule). In
applying each of the three alternative methods to a participant (including, in the
case of the 133 1/3% rule, anyone who could be a participant), § 1.411(b)-1(a)(1)
requires that the benefits under all formulas applicable to the participant must be
aggregated. Therefore, even if one formula applicable to a participant by itself
would produce a benefit that satisfies the 133 1/3% rule, and another formula by
itself would produce a benefit that satisfies the fractional rule, the total benefit
provided by the interaction of the two formulas must accrue in a manner that
satisfies at least one of the three alternative methods.

If the benefits of all participants do not satisfy the same accrual rule, the plan is
permitted to satisfy one of the accrual rules for some participants and another
accrual rule for other participants, but only if the different classification of
participants is not so structured as to evade the accrued benefit requirements of
§ 411(b)(1)(A), (B), and (C). Pursuant to § 1.411(b)-1(a)(1), this determination of
whether the different classification of participants is not so structured as to evade
the accrued benefit requirements is made with consideration of which
classification of participants is satisfying which of the three accrual rules.

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Another consideration in this determination is whether the assignment of a
participant to a classification will change merely because of the passage of time.

When determining the accrued benefit for purposes of whether a plan satisfies
the accrued benefit requirements of § 411(b)(1)(A), (B), and (C), the accrued
benefit as determined for purposes of § 411 is tested regardless of how the
accrued benefit may be defined in the plan. Thus, if the plan does not define the
accrued benefit as an annual benefit commencing at normal retirement age, the
annual benefit commencing at normal retirement age that is the actuarial
equivalent of the accrued benefit under the plan is tested to determine whether
the plan satisfies the accrued benefit requirements of § 411(b)(1)(A), (B), and
(C).

Analysis of 133 1/3% Rule in General
1

Under the 133 1/3% rule, the annual rate at which the retirement benefits
payable at normal retirement age accrue under the plan (the annual rate of
accrual) must be determined under the terms of the plan for anyone who is or
could be a participant in the plan. The annual rate of accrual with respect to a
participant is determined for the current plan year and all future plan years. Then
the annual rate of accrual for any future plan year is compared to the annual rate
of accrual for any year beginning on or after the current plan year, and before
such future plan year, to see whether the ratio of the later annual rate of accrual
to the earlier annual rate of accrual exceeds 133 1/3%.

Pursuant to § 1.411(b)-1(a)(1), the annual rate of accrual for a plan year is
determined by aggregating all benefit formulas. Furthermore, the value of all
relevant factors used to determine benefits for the current plan year is kept
constant in determining the annual rates of accrual for future years. Thus, for
example, for the plan year under consideration, which is 2002, the 3.87% interest
crediting rate, the 5.48% applicable interest rate under § 417(e)(3), and the
applicable mortality table under § 417(e)(3) are assumed to remain constant in
determining the annual rate of accrual for each plan year after 2002.

If a plan has a single benefit formula, the annual rate of accrual for a plan year is
generally determined as the increase in the accrued benefit under that benefit
formula for the plan year. If a plan has more than one benefit formula applicable
to a participant, the annual rate of accrual for the participant for the plan year
must be determined using a single methodology, such as the increase in the
dollar amount of the accrued benefit or the increase in the dollar amount of the
accrued benefit expressed as a percentage of compensation for the plan year.
Thus, the annual rate of accrual may be determined as the difference between
(A) the dollar amount of the accrued benefit as a percentage of average

1
Because the benefits provided by Plan A, both before and after the conversion, accrue over a
period of years in excess of 33 1/3 years, Plan A fails to satisfy the 3% method. Accordingly, the
analysis starts with the 133 1/3% rule.

10
compensation at the beginning of the plan year and (B) the dollar amount of the
accrued benefit as a percentage of average compensation at the end of the plan
year. In applying the 133 1/3% rule for a plan year, whichever methodology is
used to determine the annual rate of accrual must be used consistently for all
plan years (that is, the current plan year and all future plan years).

In applying the 133 1/3% rule, the analysis considers at least three groups of
employees. The three groups are (1) those who became employed after
December 31, 2001 (who will accrue benefits solely under the lump sum-based
benefit formula), (2) those who were not grandfathered participants but who were
employed on December 31, 2001 (who will accrue some benefits under the lump
sum-based benefit formula, but whose benefits were “frozen” under the pre-
conversion formula), and (3) the grandfathered participants (who will accrue
benefits for a time under both the pre-conversion formula and the lump sum-
based benefit formula).

Analysis of the 133 1/3% Rule for New Employees

For the group of new employees, the annual rate of accrual for a plan year is
most easily determined as the increase in the dollar amount of the accrued
benefit payable at the age 65 normal retirement age for a plan year expressed as
a percentage of compensation for the plan year. Thus, for any year, the annual
rate of accrual is determined by multiplying the compensation of a participant for
the plan year by the percentage from the table of pay credit percentages set forth
under the facts above, accumulating such result with hypothetical interest to age
65, converting the accumulation at age 65 to a single life annuity, and dividing
the result by compensation for the year. Accordingly, the annual rate of accrual
for a year will depend on the pay credit for the year, future interest credits, and
the conversion factor. For purposes of applying the 133 1/3% rule to the plan,
the interest crediting rate (the current year’s value of the three-year Treasury
Constant Maturity rate plus 25 basis points) and the conversion factor for future
years (using the applicable interest rate and the applicable mortality table under
§ 417(e)(3) for 2002) are assumed to be the same as for the current plan year.

For 2002, the three-year Treasury Constant Maturity rate is 3.62% (which is the
rate for December 2001), and the resulting hypothetical interest crediting rate is
3.87%. For 2002, the 30-year Treasury rate is 5.48% (the rate for December
2001) and the applicable mortality table is the table set forth in Rev. Rul. 2001-
62. The following table shows the annual rates of accrual for each age assuming
that these values for 2002 remain the same for future plan years:

Age at Beginning of Plan Year Annual Rate of Accrual

21 1.41%
22 1.35%
23 1.30%

11
24 1.26%
25 1.21%
26 1.55%
27 1.49%
28 1.44%
29 1.38%
30 1.33%
31 1.28%
32 1.24%
33 1.19%
34 1.15%
35 1.10%
36 1.06%
37 1.02%
38 0.98%
39 0.95%
40 0.91%
41 1.10%
42 1.06%
43 1.02%
44 0.98%
45 0.94%
46 0.91%
47 0.87%
48 0.84%
49 0.81%
50 0.78%
51 0.90%
52 0.87%
53 0.84%
54 0.80%
55 0.77%
56 0.75%
57 0.72%
58 0.69%
59 0.66%
60 0.64%
61 0.72%
62 0.69%
63 0.67%
64 0.64%

As may be seen by inspection of the table, the annual rate of accrual for any later
year is not more than 133 1/3% of the annual rate of accrual for any earlier year
and, thus, the lump sum-based benefit formula standing alone satisfies the 133
1/3% rule. For example, in considering a participant who is age 21 in 2002, the

12
highest ratio of any future annual rate of accrual to any earlier rate is 128.1%
(which is less than 133 1/3%). This occurs at age 26, where the ratio of 1.55%
(which also happens to be the highest rate of accrual) to the 1.21% rate for age
25 (which is the smallest rate between ages 21 and 26) is 128.1%.

Analysis of the 133 1/3% Rule for Participants Who Are Not Grandfathered
Participants

For participants who were employed on December 31, 2001, and who were not
grandfathered participants, the accrued benefit under the pre-conversion formula
does not increase after 2001, and the participants will only accrue benefits under
the lump sum-based benefit formula. However, whether there is any increase in
the accrued benefit of a participant will depend on the extent to which the new
lump sum-based benefit formula provides a benefit that exceeds the benefit that
had been accrued under the pre-conversion formula as of December 31, 2001.
If, for a period of years, the lump sum-based benefit formula does not provide a
greater benefit than the frozen accrued benefit under the pre-conversion formula
as of December 31, 2001, then there is a period where the annual rate of accrual
is zero. After that period, there will be a period of a positive annual rate of
accrual as the lump sum-based benefit formula begins to provide a benefit that
exceeds the frozen accrued benefit under the pre-conversion formula.

Ordinarily, a period of a zero annual rate of accrual followed by a period of
positive annual rates of accrual would result in a plan failing to satisfy the 133
1/3% rule. However, because there is no ongoing accrual under the pre-
conversion formula for these participants for service after the January 1, 2002
effective date of the conversion amendment, the lump sum-based benefit formula
is the only formula under the plan (other than the § 411(d)(6) protected benefit),
and, pursuant to the special rule of § 411(b)(1)(B)(i), that formula is treated as if it
were in effect for all other plan years. Accordingly, the benefits under the lump
sum-based benefit formula are the only benefits that need to be considered for
purposes of applying the 133 1/3% rule (and the § 411(d)(6) protected benefit
under the pre-conversion formula accrued through the date of conversion is
disregarded in applying § 411(b)(1)(B)). As illustrated above, the lump sum-
based benefit formula standing alone satisfies the 133 1/3% rule, and Plan A
thus satisfies the rule for participants who are not grandfathered participants.

Analysis of the 133 1/3% Rule for Grandfathered Participants Age 61 and Above

For participants who are grandfathered participants, the pre-conversion formula
continues for a period of four years after the effective date of the amendment and
thus is not disregarded pursuant to the special rule of § 411(b)(1)(B)(i). For
grandfathered participants who are age 61 or above on January 1, 2002, the pre-
conversion formula continues at least through normal retirement age (age 65),
and, based upon calculations using the 3.87% crediting rate and the applicable
interest rate and applicable mortality table, such participants have an annual rate

13
of accrual of 1.1%, the rate of accrual under the pre-conversion formula (because
the lump sum-based benefit formula never provides a higher benefit). Thus, the
annual rate of accrual through normal retirement age will continue to be 1.1% of
highest average compensation, and the plan satisfies the 133 1/3% rule with
respect to those participants.

Analysis of the 133 1/3% Rule for Grandfathered Participants Below Age 61 Who
Do Not Accrue Additional Benefits Under the Lump Sum-Based Benefit Formula
Before Normal Retirement Age

For grandfathered participants who are at least age 50 and not yet age 61 on
January 1, 2002, the pre-conversion formula provides a greater benefit for the
next four years after the amendment (assuming, as required under
§ 411(b)(1)(B)(iv), that the relevant factors used to compute benefits as of 2002
are held constant in the future). Thereafter, the accrued benefit under the pre-
conversion formula does not increase, and the participants will only accrue
benefits under the lump sum-based benefit formula. However, whether there is
any increase in the accrued benefit of a participant after 2005 and before normal
retirement age will depend on the extent to which the new lump sum-based
benefit formula provides a benefit that exceeds the benefit that had been accrued
as of December 31, 2005. If there is a period of time after December 31, 2005
when the benefit under the pre-conversion formula (taking into account service at
least through December 31, 2005) remains larger than the benefit under the lump
sum-based formula, then there will be a period of zero annual rates of accrual.
Assuming that the relevant factors in effect for the 2002 plan year remain the
same for all future plan years, for grandfathered participants who are at least age
55 and not yet age 61 on January 1, 2002, the period of zero annual rates of
accrual extends at least through the age 65 normal retirement age, because the
benefit payable at age 65 under the plan will be the accrued benefit under the
pre-conversion formula as of December 31, 2005. Because the annual rate of
accrual for these participants changes from 1.1% to zero, and then does not
increase prior to normal retirement age, Plan A satisfies the 133 1/3% rule with
respect to these participants for 2002.

Analysis of the 133 1/3% Rule for Grandfathered Participants Below Age 61 Who
Do Accrue Additional Benefits Under the Lump Sum-Based Benefit Formula
Before Normal Retirement Age (Age 50 to 55)

For grandfathered participants who are at least age 50 and not yet age 55 on
January 1, 2002, assuming as required under § 411(b)(1)(B)(iv) that the relevant
factors used to compute benefits as of 2002 remain constant in the future, the
period of zero accruals after 2005 will be followed by a period of annual rates of
accrual prior to normal retirement age greater than zero. In such a case, the
later annual rate of accrual which is greater than zero will exceed 133 1/3% of
the zero annual rate of accrual, and thus Plan A does not satisfy the 133 1/3%
rule with respect to these participants for 2002.

14

The effect on grandfathered participants who are at least age 50 and not yet age
55 on January 1, 2002, may be illustrated by a participant who commenced
participation at age 35 with compensation of $40,000. Assume that the
participant’s compensation increased at the rate of 3% per year in the years
before 2002. The participant on December 31, 2001, was age 50, had 15 years
of service, and had highest average compensation of $58,758. Accordingly, the
participant’s accrued benefit at that date is $9,695 per year (1.1% of $58,758
multiplied by 15 years of service) payable at normal retirement age. At age 54, 4
years after the conversion, assuming the participant’s compensation remains
constant at the 2001 level, the participant would have an accrued benefit under
the pre-conversion formula of $12,645 per year (1.1% of $60,504 multiplied by 19
years of service) payable at normal retirement age. The opening account
balance at January 1, 2002, is $49,352. Taking into account expected
hypothetical contributions to the account in accordance with the table of pay
credit percentages above, and assuming that the hypothetical account is credited
with interest at 3.87%, the cash balance account would provide a benefit of less
than $12,645 for the first 9 plan years after conversion. Therefore, there would
be a period of approximately 5 plan years (after the 4-year period of continued
accruals under the pre-conversion formula) for which the participant has no
increase in his or her accrued benefit (i.e., effectively an annual rate of accrual of
zero). In approximately the 10th plan year after the conversion, the participant
would have a small annual rate of accrual and the participant would have a
relatively larger annual rate of accrual in the remaining 5 plan years until age 65.

Thus, there are some grandfathered participants who are at least age 50 and not
yet age 55 with respect to whom Plan A fails to satisfy the 133 1/3% rule for
2002. Accordingly, Plan A cannot satisfy the accrual rules unless it can satisfy
the accrual rules through the use of the fractional rule. While the fractional rule
cannot effectively be used on a permanent basis for Plan A (for the reasons
discussed below), the post-conversion transitional accruals under the pre-
conversion formula result in a pattern of accrued benefits that may satisfy the
fractional rule on a temporary basis for the grandfathered participants who are at
least age 50 and not yet age 55 on January 1, 2002. Therefore, Plan A may be
able to satisfy the accrual rules using the fractional rule for these participants,
and the 133 1/3% rule for the other participants.

Analysis of Fractional Rule for Grandfathered Participants Age 50 to 55

In order to apply the fractional rule to the grandfathered participants in Plan A
who do not satisfy the 133 1/3% rule, the fractional rule benefit must be
determined for each such participant. This benefit is determined under the terms
of the plan by assuming that participation continues to normal retirement age,
and that all relevant factors used to determine benefits are kept constant as of
the current year for all years after the current year. The fractional rule benefit for
a participant is also determined by reflecting all of the participant’s prior

15
compensation and years of participation, and assuming that the participant
continues to earn the same rate of compensation in future years that is taken into
account under the plan, but taking into account no more than 10 years of
compensation. For this purpose, the number of years of compensation that
would be taken into account under the plan, pursuant to § 411(b)(1)(C) and
§ 1.411(b)-1(b)(3)(ii)(A), is determined as if the participant had attained normal
retirement age on the date the determination is made.

The fractional rule benefit, as so determined, is multiplied by a fraction, the
numerator of which is the number of years of participation at each future point,
and the denominator of which is the number of years of participation the
participant will have if participation continues through normal retirement age. If,
for the current plan year and each future plan year, the accrued benefit under the
plan equals or exceeds the result obtained by multiplying the fractional rule
benefit by the applicable fraction for that year, the plan satisfies the fractional rule
with respect to that participant for the current plan year.

For grandfathered participants who are at least age 50 and not yet 55 on January
1, 2002, the fractional rule benefit is the greater of the benefit that is projected to
be provided by the pre-conversion benefit formula and the benefit that will be
provided by the hypothetical account of each participant, based upon the
participation and compensation history of the participant. In determining the
benefit that will be provided by the hypothetical account, future pay credits are
determined by assuming that compensation for each future year is equal to the
average of the compensation taken into account under the plan for the
immediately preceding 10 years of participation (or for all years of participation
for employees with less than 10 years of participation).

The fractional rule benefit for a participant may be determined at a date as
illustrated by the following steps:

(1) Assuming that the participant had no additional service, participation, or
compensation after the date of determination, determine which benefit formula
would provide the benefit payable at normal retirement age under the plan
(based on all other relevant factors on such date).

(2) For the formula determined in step (1), determine the number of years of
service for which compensation is taken into account under that formula as of the
determination date. For this purpose, where the lump sum-based benefit formula
is the formula in step (1) and the plan provided for the establishment of an
opening account balance equal to the present value of the accrued benefit
determined under the pre-conversion formula, the number of years of service is
the number of years of service taken into account in determining that balance,
plus one year for each year since the initial account balance was determined.

16
(3) Determine the participant’s average compensation as of the determination
date for the immediately 10 preceding years or, if less, the number of years
determined in step (2).

(4) Assume that the participant’s compensation for each future year of
participation until attainment of normal retirement age is the average
compensation determined in step (3).

(5) Determine the participant’s fractional rule benefit as the benefit that would be
payable upon attainment of normal retirement age under the plan by applying the
plan formulas based on future participation using the compensation determined
under step (4) and based on the assumption that all other relevant factors remain
constant through normal retirement age at the values for the date on which the
determination is being made.

Under these facts, where the pattern of accruals results from a transition from a
final average pay formula that satisfies the fractional rule to an accumulation
formula that satisfies the 133 1/3% rule by providing the greater of the benefit
under the final average pay formula or the benefit under the lump sum-based
benefit formula during the transition period, the classification of participants
between at least age 50 and not yet age 55 on January 1, 2002 (including the
use of the fractional rule with respect to such participants) is not a classification
that is structured to evade the accrued benefit requirements of § 411(b)(1)(A),
(B), and (C) or § 1.411(b)-1. Accordingly, the grandfathered participants in Plan
A whose annual rate of accrual fails the 133 1/3% rule may pass the accrual
rules of § 411(b)(1)(A), (B), and (C) by using the fractional rule.

To illustrate this, consider the grandfathered participant described above who
commenced participation at age 35. For the plan year under consideration,
which is 2002, this participant had a projected benefit at the age 65 normal
retirement age under the pre-conversion 1.1% formula (based on service through
the end of the grandfathering period and using the compensation determined
under Steps 1 through 4 above, which is $58,758) equal to $12,281. The
projected benefit from the hypothetical account balance at the age 65 normal
retirement age (assuming the pay credit percentages under the table above and
future compensation of $58,758, and that the 3.87% interest crediting rate, the
5.48% applicable rate, and the applicable mortality table remain the same for
future years) is $13,999. Therefore, the fractional rule benefit is $13,999. As
may be seen from the following table, the accrued benefit under the plan (the
greater of the $12,281 benefit under the prior 1.1% formula and the benefit
provided by the hypothetical account balance) is not less than the pro rata
portion of the fractional rule benefit at the end of each future year. Accordingly,
the benefit with respect to this participant satisfies the fractional rule for 2002.

17

Accrued Benefit at
Age
2
Fraction Fraction times $13,999 End of Year Per Plan

51 16/30 $7,466 $10,341
52 17/30 $7,933 $10,998
53 18/30 $8,399 $11,634
54 19/30 $8,866 $12,281
55 20/30 $9,333 $12,281
56 21/30 $9,799 $12,281
57 22/30 $10,266 $12,281
58 23/30 $10,733 $12,281
59 24/30 $11,199 $12,281
60 25/30 $11,666 $12,281
61 26/30 $12,132 $12,461
62 27/30 $12,599 $12,867
63 28/30 $13,066 $13,259
64 29/30 $13,532 $13,636
65 30/30 $13,999 $13,999

Because the accrued benefit of this participant at any future point will not be less
than the result obtained by multiplying the fractional rule benefit by the ratio of
the number of years of participation to that point to the total number of years of
participation the participant will have at normal retirement age, Plan A satisfies
the fractional rule for this participant for 2002.

If Plan A can make a similar demonstration for all grandfathered participants at
least age 50 and not yet age 55 on January 1, 2002, then Plan A can satisfy the
fractional rule for these participants and the 133 1/3% rule for all other
participants. Under the facts presented, it is expected that such a demonstration
will show that, for 2002, the fractional rule is satisfied for all participants whose
accrual patterns were unable to satisfy the 133 1/3% rule.
3

HOLDING

Plan A satisfies the 133 1/3% rule of § 411(b)(1)(B) for 2002 for all participants
except the grandfathered participants who are at least age 50, but not yet age
55, on January 1, 2002. Under the above facts, the class of grandfathered
participants who are at least age 50, but not yet age 55, on January 1, 2002, is
not a classification that is structured to evade the accrued benefit requirements of

2
Age at the end of the plan year.
3
It is similarly likely that a demonstration will show that, for 2002, the fractional rule is satisfied for
all grandfathered participants age 55 or above on January 1, 2002. Also, the use of the fractional
rule with respect to all such participants is not a classification that is so structured as to evade the
accrued benefit requirements of § 411(b)(1)(A), (B), and (C) and § 1.411(b)-1.

18
§ 411(b)(1)(A), (B), and (C) and § 1.411(b)-1 so that the fractional rule may be
used for these participants. With respect to the grandfathered participants who
are at least age 50, but not yet age 55, on January 1, 2002, if the accrued
benefits of these participants satisfy the fractional rule of § 411(b)(1)(C) as set
forth in this revenue ruling, Plan A satisfies the accrual rules of § 411(b)(1)(A),
(B), and (C) for 2002.

Satisfaction of Accrual Rules in Future Years

The analysis and holding in this revenue ruling only address the 2002 plan year.
It is possible for a plan described in the facts of this revenue ruling to fail to
satisfy the accrual rules of § 411(b)(1)(A), (B), and (C) for a subsequent year,
either due to changes in relevant factors that are treated as constant for any
given year or due to changes in facts relating to plan participants. For example,
in the facts addressed in this revenue ruling, whether the pattern of increasing
pay credits results in an annual rate of accrual which is more than 133 1/3% of
the annual rate of accrual for any earlier year is affected by the rate of interest
that is credited under the plan (which is treated as constant for all future years for
purposes of applying the accrual rules of § 411(b)(1)(A), (B), and (C) to any
year). In the year 2002, that interest rate is 3.87%. If the rate of interest credited
under the plan for a later year were to be less than 1.58%, Plan A would not
satisfy the 133 1/3% rule for that later year for participants who are not
grandfathered participants and thus would need to be amended in order to satisfy
the 133 1/3% rule.

As another example, if the grandfathered participant described above who did
not satisfy the 133 1/3% rule were to continue to have compensation increases in
years after 2002 at an annual 3% rate, then by 2013 the fractional rule benefit
would be so large that the aggregate accrued benefit of the participant for that
year would be less than the result obtained by multiplying that larger fractional
rule benefit by the applicable fraction (the number of years of participation to that
time to the total number of years of participation the participant will have at
normal retirement age). Accordingly, even compensation increases that are
regular and predictable can result in Plan A failing to satisfy the fractional rule for
the grandfathered participants. Moreover, the possible volatility resulting from
unpredictable future compensation increases is a major reason why the fractional
rule cannot effectively be used on a permanent basis for plans such as Plan A.

If changes to relevant factors such as a decrease in the interest crediting rate or
an increase in future compensation were to result in a failure to satisfy the
accrual rules, the plan’s benefit formula would need to change. Some of the
types of changes that may be used are outlined below with respect to Plan A.
Any change would need to satisfy applicable qualification requirements, including
satisfaction of the anticutback rules of § 411(d)(6) and the requirement that a
plan provide benefits that are definitely determinable.

19
In order to bring the plan into compliance in the event of a decrease in the
interest crediting rate, Plan A’s benefit formula could be changed to increase the
hypothetical pay credits at the earlier ages, reduce the hypothetical pay credits at
the higher ages, or a combination of an increase at the lower ages and a
reduction at the higher ages. The resulting pattern of pay credits would have to
be less steep than before in order for the 133 1/3% rule to be satisfied using the
lower interest crediting rate. Plan A could also provide an interest crediting rate
higher than 1.58% for that year and all future years for participants for whom the
133 1/3% rule is not satisfied, but any such minimum rate could not result in a
rate of interest which exceeds a market rate of interest under § 411(b)(5)(B)(i)(I),
as added to the Code by PPA ‘06.

It may be possible that Plan A could be changed to adjust the hypothetical pay
credits to ensure compliance with the accrual rules of § 411(b)(1)(A), (B), and (C)
for future years. Such a provision would need to provide that if the interest
crediting rate at the beginning of any plan year is less than 1.58%, the
hypothetical pay credits are adjusted so that the resulting pattern of pay credits
satisfies the 133 1/3% rule using the interest crediting rate for the year. Any such
possible provision would need to include specific rules on how the adjustment is
made, which would typically be dependent on the extent to which the interest
crediting rate is less than 1.58%. Furthermore, the provision would need to be
clear as to what happens in future years should the interest crediting rate again
change. Note that it may be difficult to design such provisions and, furthermore,
difficult to put them into effect in actual plan operations on a timely basis.

With respect to the possibility that compensation increases for any future year
may result in a plan failing to satisfy the fractional rule for that year, provisions
would be necessary either to ensure that the plan could instead satisfy the 133
1/3% rule for that year (as described in the preceding two paragraphs) or to
provide a combination of increases in the accrued benefit for earlier years or
decreases in the accruals for future years (but § 411(d)(6) would not permit
decreases for service before the applicable amendment date) in order to satisfy
the fractional rule for that year. However, unlike the discussion above
concerning interest crediting rates, it is not clear how a provision to alter accrual
rates or accrued benefits could be implemented annually by a plan provision in
the absence of relevant participant information such as the compensation history
through the plan year. It may be possible to limit the compensation taken into
account for any participant by providing that only compensation increases up to
some specified percentage are taken into account. However, any such provision
would be difficult to design and extremely difficult to put into effect in actual plan
operations on a timely basis.

Section 7805(b) Relief

Under the authority of § 7805(b), this paragraph provides relief for plans under
which a group of employees specified under the plan receives a benefit equal to

20
the greatest of the benefits provided under two or more formulas (an applicable
“greater-of” benefit), provided that each such formula standing alone would
satisfy an accrual rule of § 411(b)(1)(A), (B), or (C) for the years involved. This
relief applies to a plan only if either: (1) as of February 19, 2008, the plan
provisions under which the applicable “greater-of” benefit is provided have been
the subject of a favorable determination letter; (2) as of February 19, 2008, a
remedial amendment period under § 401(b) for the plan provisions under which
the applicable “greater-of” benefit is provided has not expired; or (3) the plan is
otherwise a “moratorium plan” as defined in Notice 2007-6. Under the relief set
forth in this paragraph, for plan years beginning before January 1, 2009, the
Service will not treat a plan described in the preceding sentence as failing to
satisfy the accrual rules of § 411(b)(1)(A), (B), and (C) solely because the plan
provides an applicable “greater-of” benefit, where the separate formulas,
standing alone, would satisfy an accrual rule of § 411(b)(1)(A), (B), and (C). For
this purpose, a plan described in (2) that provides a group of employees
specified under the plan an applicable “greater-of” benefit can be retroactively
amended
4
so that each formula, standing alone, would satisfy an accrual rule of
§ 411(b)(1)(A), (B), and (C) for the years involved. For example, a moratorium
plan that has a determination letter request pending under which the lump-sum
based benefit formula standing alone fails to satisfy the accrual rules of
§ 411(b)(1)(A), (B), and (C) for a plan year beginning before January 1, 2009
(because the interest credits under the plan are insufficient to compensate for the
effect of age-based or service-based pay credits) can be retroactively amended
so that the lump-sum based benefit formula satisfies an accrual rule of
§ 411(b)(1)(A), (B), and (C) for the years involved.

The relief under the prior paragraph does not extend to other issues under § 411.
Accordingly, before a favorable determination letter can be issued, the plan must
otherwise satisfy the requirements of § 411.
5
Thus, for example, in order to avoid
a forfeiture of the accrued benefit under the plan for purposes of § 411, or to
ensure compliance with the accrual rules of § 411(b)(1)(A), (B), and (C), the
annual benefit payable at normal retirement age attributable to the lump sum-
based benefit formula at the end of the current year must not change thereafter,
assuming that no change were to occur in any relevant factor used to determine
benefits and disregarding any future pay credits (e.g., under the plan, the annual
benefit payable at normal retirement age attributable to the lump sum-based
benefit formula as of the end of a year cannot increase or decrease after that
year due merely to operation of the plan and the passage of time, as opposed to
additional pay credits or changes in a relevant factor used to determine benefits).

DRAFTING INFORMATION

4
Any such amendment must satisfy the anticutback rules of § 411(d)(6).
5
As provided by Notice 2007-6, issues as to whether the conversion satisfies the requirements of
§ 411(b)(1)(H) will generally not be considered for plans where the conversion is before June 30,
2005.

21
The principal author of this revenue ruling is James E. Holland, Jr. of the
Employee Plans, Tax Exempt and Government Entities Division. Mr. Holland
may be reached by e-mail at RetirementPlanQuestions@irs.gov.