Target Benefit Plans
What is a Target Benefit Plan?
A target benefit plan is a special type of money purchase pension plan which provides unguaranteed retirement benefits to employees due to the fact that retirement benefits are directly correlated to investment gains or losses.
The employer who offers the target benefit plan will set up a separate account for each participant and will contribute a fixed amount of dollars into this account every year until retirement in order to reach a predetermined retirement benefit amount.
How do a Defined Benefit Plan & Target Benefit Plan Differ?
There are two distinct differences between the two plans. The main difference lies in the monthly retirement payments. With the defined benefit plan, a set amount is guaranteed, regardless of the performance of the investments in the defined benefit plan. With the target benefit plan, the monthly payments due at retirement are at the mercy of the performance of the investments. If the performance is better than expected, the employee will receive a higher monthly payment and vice versa.
The second key difference lies in the monthly contributions made into each of the employee accounts, on behalf of the company. With a defined benefit plan, the employer will contribute as much as is necessary on a monthly basis to reach the anticipated goals at retirement. For example, if the investments in the account were not performing as well as intended, the company would increase the contribution to make up for that difference. With the target benefit plan, the amount of contribution is set in stone after year 1.
This is where the employee can be at a major disadvantage. If any of the assumptions used to guestimate the monthly contributions needed to hit the retirement goal are incorrect, the employer is not liable to adjust the contribution amount to hit the retirement goals.
If you really look at the structure of this vehicle, it is a cross between the money purchase pension plan and the defined benefit plan. The only real difference between a money purchase pension plan and a target benefit plan lies in the calculation of the contribution. Money purchase plans use a percentage of salary while the target benefit plan backs into the monthly contribution amount based on the targeted retirement benefit.
Who Benefits from a Target Benefit Plan?
Typically, older employees will benefit the most from a target benefit plan. This is due to the fact that AGE is a key factor in the formula used to determine the monthly contribution amounts by the employer. The greater the age, the less time the employer has to fund the plan adequately. For this reason, older employees receive higher contributions in order to match their retirement goals.