Target-Benefit Plan

Target-Benefit Plan

A target-benefit plan is one that is similar to a defined benefit (DB) plan in which contributions are based on projected retirement benefits. It is similar to a defined benefit plan, yet, unlike a defined benefit plan, the retirement distributions are paid to participants in a target-benefit plan are not guaranteed. Monthly benefits in target-benefit plans can increase when the market performs well, but decrease following market downturns. Target-benefit plans do offer more certainty than defined-contribution plans or 401(k)s. A target-benefit plan is one that is similar to a defined benefit (DB) plan in which 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.

A target-benefit plan offers contributions that are based on projected retirement benefits.

What Is a Target-Benefit Plan?

A target-benefit plan is one that is similar to a defined benefit (DB) plan in which 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.

Note that a target benefit plan is not the same as a target-date fund, which may be found in defined contribution (DC) retirement accounts like 401(k) plans.

A target-benefit plan offers contributions that are based on projected retirement benefits.
It is similar to a defined benefit plan, yet, unlike a defined benefit plan, the retirement distributions are paid to participants in a target-benefit plan are not guaranteed.
The market impacts a target-benefit plan.
Monthly benefits in target-benefit plans can increase when the market performs well, but decrease following market downturns.
Target-benefit plans do offer more certainty than defined-contribution plans or 401(k)s.

How a Target-Benefit Plan Works

Target-benefit plans have some attributes of pension plans in that they offer a monthly benefit to the participants or employees. However, a target-benefit plan shifts the risk of whether there are enough funds in the plan to the employees, whereas in a pension plan, the risk is solely on the employer to provide the benefits.

A target-benefit plan provides employees with an estimated target of the monthly benefit, but that target can change over time, depending on the investment returns. In other words, there's no guarantee that the monthly benefit will be there in retirement, nor is there a guarantee of the monthly amount.

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.

Defined-Contribution Plans

A target-benefit plan does share some similarities to a defined-contribution (DC) plan, such as a 401(k). Defined contribution 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.

In both a DC plan and target-benefit plan, the funds are invested to generate returns so that there will be enough money in retirement for the employees. Also, similar to a 401(k), employees bear the risk that there might not be enough money in the fund. However, the benefit paid to the employee under a target benefit plan–although not guaranteed–can be more certain than the benefits under a defined contribution plan.

A target-benefit plan provides employees with an estimated target of the monthly benefit. Still, there's no guarantee that the monthly benefit will be there in retirement, nor is there a guarantee of the monthly amount.

Target-Benefit Plans vs. Defined-Benefit Plans

There are drawbacks to both DB and DC plans. While defined-benefit plans require employers to take larger risks, defined-contribution plans shift the burden of these risks onto the individual workers and retirees. Both have had mixed results.

Defined benefit 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 while target-benefit plans are not guaranteed.

Cash Balance Plan

There are other variations of defined benefit plans that include a cash balance. 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.

412(i) Plan

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 investments that can fund this type of plan are guaranteed annuities or a combination of annuities and life insurance. The funds in a 412(i) plan are guaranteed by an insurance company.

The asset or investment values, as well as the monthly benefits in target-benefit plans, are a moving target. In other words, the benefits are reduced following market downturns and increased when the market performs well. However, target-benefit plans can offer more certainty than defined-contribution plans. Target-benefit plans have arisen in many places outside of the U.S., including the U.K. and the Netherlands.

Related terms:

412(i) Plan

A 412(i) plan was a defined-benefit pension plan that was designed for small business owners in the United States. read more

Annuities: Insurance for Retirement

An annuity is a financial product that pays out a fixed stream of payments to an individual, primarily used as an income stream for retirees.  read more

Asset Accumulation

Asset accumulation is building overall wealth through earning, saving, and investing money over time. read more

DB(k) Plan

A DB(k) plan is a hybrid retirement plan that combines some of the characteristics of a defined contribution 401(k) plan with those of a defined benefit (DB) plan. read more

Defined-Benefit Plan

A defined-benefit plan is an employer-sponsored retirement plan where benefits are calculated on factors such as salary history and duration of employment. read more

Defined-Contribution Plan

A defined-contribution plan is a retirement plan in which employees contribute part of their paychecks to an account intended to fund their retirements. read more

Insurance

Insurance is a contract (policy) in which an insurer indemnifies another against losses from specific contingencies and/or perils. read more

Matching Contribution

A matching contribution is a type of contribution an employer chooses to make to their employee's employer-sponsored retirement plan. read more

Money Purchase Pension Plan

A money purchase pension plan is a type of retirement savings plan that has some of the attributes of a company profit-sharing plan. read more

Pension Benefit Guaranty Corporation (PBGC)

The Pension Benefit Guaranty Corporation is a federal agency that protects the pension plans of many workers in the private sector. read more