# Interest crediting rates

> Fixed, Treasury-based, or actual return. How the choice affects owners and staff.

Source: https://askactuary.com/interest-credits  
Author: Mike Rutkowski, FSA, EA, MSPA

The interest crediting rate decides how participant accounts grow between pay credits. It is also the main lever for how much investment risk stays with the employer.

## The short version

- The plan document fixes the crediting rate. The employer generally can't change it once set.
- IRS rules cap the rate at a "market rate of return." A fixed rate can be no higher than 6%.
- Crediting the plan's actual return (technically) shifts most investment risk to participants. For owner only plans, the owner IS the participant. For plans with employees, the owner generally has the vast majority of the cash balance total, and therefore still retains most of the investment risk.

## The common choices

| Rate type | How it works | Good fit when |
| --- | --- | --- |
| Fixed rate | A set rate every year, often 4% to 5% | This is the recommended design for small, owner-dominant plans |
| Treasury-based | Tied to a published yield, such as the 30-year Treasury rate | Poor design choice for small, owner-dominant plans |
| Actual return | Accounts earn what the plan's assets earn, with protections | Poor design choice for small, owner-dominant plans |

## Why the rate matters for funding

The actuary funds the plan so that assets keep pace with the account balances (plans with employees), or strategically exceed the account balances by a growing amount (for owner only plans).

- **Assets beat the crediting rate:** the plan builds a surplus, and future minimums fall. Too much surplus near the end of the plan can become a problem. See [Investments and risk](https://askactuary.com/investments).
- **Assets trail the crediting rate:** the plan develops a shortfall, and future minimums rise to close it, generally over fifteen years. This amortization protects against drastically increasing minimums when there is a loss. As an example, an asset loss of $100,000 will generally only increase the minimum contribution by about $10,000.

## Protections for participants

Federal rules limit how the crediting rate can work. A few that come up often:

- The rate cannot exceed a market rate of return, and a fixed rate is capped at 6%.
- With an actual-return rate, interest credits can be negative in a bad year. But when the benefit is paid, a participant must receive at least the sum of their pay credits.
- Changing the rate is a plan amendment. Benefits already earned are protected, so a change usually applies only going forward (to pay credits earned after the amendment).

**Actuary's note**

For a number of reasons, we recommend only fixed interest crediting rates, and commonly use **4% or 5%**.

Why not a market-based rate?

- **Owner-only plans.** A market-based rate doesn't allow the minimum contribution to decrease over time as easily as a fixed rate does.
- **Plans with employees.** Large swings in asset returns can cause wild swings in the annual nondiscrimination testing results, resulting in larger required contributions for employees.
- **At plan termination.** Owners are forced to share much more of the aggregate surplus asset returns with employees than they would with a fixed crediting rate.
- **Employee communication.** When market returns are negative, communication with employees gets tough, since participants can't control the investments the way they can in their 401(k).

**Our recommendation:** keep it simple and use 4% or 5%. The actuary will strategically make the appropriate design choice when the plan is established. Pay credits drive the plan design, not the interest credits.

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Educational information only. Not tax, legal, or investment advice, and not an actuarial valuation.
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