DEFINITION of Target-Benefit Plan
A target-benefit plan is one that is similar to a defined benefit (DB) plan whereby contributions are based on projected retirement benefits. However, unlike a defined benefit plan, the distributions that participants in a target-benefit plan receive at retirement are based on the performance of the investments and are, therefore, not guaranteed.
How a Target-Benefit Plan Works
The target benefit plan also bears some similarity to a money purchase plan in that contributions are mandatory. In a money purchase plan, an employee or employer makes annual contributions according to the percentage that the plan requires. For example, a plan that requires a contribution of 5% means the employer contributes 5% of each eligible employee’s pay to his or her separate account annually. Contributions must be made whether or not the business makes a profit.
Target-Benefit Plan and Defined Benefit Plans
Defined benefit (or DB) plans are slightly wider in scope than target-benefit plans. In a defined benefit pension plan, a participant receives a fixed benefit in retirement based upon compensation, age, and years of service with a particular employer.
DB plans are guaranteed by the Pension Benefit Guaranty Corporation (PBGC), a federal government agency. Variations of the defined benefit plan include cash balance and 412(i) plan, in addition to the traditional option.
In a cash balance plan, an employer credits a participant's account with a set percentage of his or her yearly compensation plus interest. The company solely bears all ownership of profits and losses in the portfolio. In a tax-qualified 412(i) plan, designed for small businesses, any amount that the owner contributes to the plan becomes available immediately as a tax deduction to the company. The only things that can fund this type of plan are guaranteed annuities or a combination of annuities and life insurance.
In contrast with defined benefit plans, defined contribution (or DC) plans are those retirement plans in which employees contribute a fixed amount or a percentage of their paychecks each cycle. An employer will often match an employee’s regular contribution to a DC plan. A 401(k) is an example of a defined contribution plan.
Recent News About Target-Retirement Plans
There are drawbacks in both DB and DC plans. While DB plans require employers to take larger risks, DC plans shift the burden of these risks on the onto individual workers and retirees. Both have had mixed results. To this end, target-benefit funds have arisen in many places outside of the U.S., including the U.K. and the Netherlands. A 2018 Bloomberg article highlighted that in these models, when asset value and longevity of the fund(s) change, the benefits are adjusted downward in a down market and upward in a good market.