A target benefit plan is a cross between a defined benefit plan and a money purchase pension plan. It is like a defined benefit plan in that the annual contribution is determined by the amount needed each year to accumulate (at an assumed rate of interest) a fund sufficient to pay a projected retirement benefit -- the target benefit -- to each participant on reaching retirement age. Thus, if a target benefit plan contains a target formula, such as 40 percent of compensation, that is identical to the benefit formula in a defined benefit plan and is based on identical actuarial assumptions, e.g., interest rates, mortality, employee turnover, the employer's initial contribution for the same group of employees will be the same. The similarity ends there.
In a defined benefit plan, if the actual experience of the plan differs from the actuarial assumptions used (for example, if the interest earned is higher or lower than the assumptions), then the employer either increases or decreases its future contributions to the extent necessary to provide the promised benefits. In a target benefit plan, however, the contribution, once made, is allocated to separate accounts maintained for each participant. Thus, if earnings of the fund differ from those assumed, this does not result in any increase or decrease in employer contributions; instead, it increases or decreases the benefits payable to the participant.
In this regard, the target benefit plan operates like a money purchase pension plan. In fact, the only difference between a money purchase pension plan and a target benefit plan is that in a money purchase plan, contributions are generally determined and allocated as a percentage of current compensation. In a target benefit plan, contributions are determined as if the plan were to provide a fixed benefit. In a money purchase pension plan, contributions for identically compensated employees are the same even though their ages differ; in a target benefit plan, age is one of the factors that determines the size of the contributions. Because older employees have less time in which to have their benefits funded, employer contributions on their behalf are greater, as a percentage of compensation, than for younger employees. Consequently, target benefit plans appeal to employers that desire to benefit older employees.
