Target benefit plan

A target benefit plan is a type of pension plan that contains features of a defined contribution plan but is made to appear like a defined benefit plan.

It is similar to defined benefit plan in that the annual contribution is determined by a formula to calculate the amount needed each year to accumulate (at an assumed interest rate) a fund sufficient to pay a projected retirement benefit, the target benefit, to each participant upon reaching retirement. It is similar to a defined contribution plan in that the plan does not guarantee any benefit will be paid. The plan's only obligation is to pay whatever benefit can be provided by the amount in the contributor’s account. The actual earnings on the individual accounts may differ from the estimated earnings used in the assumptions and the investment performance of that account through the years.

Targets

A target may be set based on final salary. For example, if the defined benefit plan being "targeted" has a benefit of 1.5% of the final salary for each year of credited service, payable at age 65, then the contribution level for a 25-year-old entrant is found by an actuary calculating what contribution level would result in a benefit of 60% of the entrant's final salary. This requires the use of actuarial assumptions of interest rates, salary growth and mortality. If the assumption for salary growth is less than that for interest then the contribution rate for older entrants would be greater than that for younger entrants.

Because a target benefit plan is a defined contribution plan and because most defined contribution plans shift investment risk to the plan participant, there is no guarantee that the target will be met, because the assumptions may not be borne out. If actual salary growth exceeds the level assumed then the actual benefit will tend to be lower than the targeted amount. If the actual investment returns exceed those assumed then actual benefits will tend to be higher than the targeted amount.

See also

• 401(k)
• Individual Retirement Account
• Retirement plan
• Target date fund