What is it?
A target benefit plan is a type of money purchase pension plan. It is often referred to as a “hybrid” plan because, although a money purchase pension plan, target benefit plans include features commonly associated with a defined benefit plan. Like a defined benefit plan, annual contribution calculations are based upon a specified projected retirement benefit (the target benefit). However, as with other money purchase pension plans, annual contributions (which are both fixed and mandatory) are made to individual participant accounts, and the actual retirement benefit a participant ultimately receives depends upon his or her individual account balance.
Tip: Because target benefit plans utilize participant age as one of the factors in determining plan contributions, these plans generally result in a contribution allocation that tends to benefit older participants.
Tip: A target benefit plan is a type of qualified defined contribution plan. For a general description of both qualified plans and defined contribution plans, see our separate topic discussion, Retirement Plans.
Caution: Target benefit plans have become increasingly less common. To a large extent, this is attributable to the increased adoption of cross-tested profit sharing plans (e.g.,age-weighted profit-sharing plans), which offer comparable advantages but are generally more flexible.
Tip: Prior to the Economic Growth and Tax Relief Reconciliation Act of 2001 (2001 Tax Act), limits on the tax-deductibility of employer contributions to retirement plans favored money purchase pension plans (and therefore target benefit plans) over profit-sharing plans (employers could deduct up to 25 percent of total compensation for contributions made to a money purchase pension plan, but only up to 15 percent of total compensation for contributions made to a profit-sharing plan). The 2001 Tax Act, however, increased the limitation on tax-deductible contributions to profit-sharing plans to 25 percent. With this change, most employers will find it to their advantage to adopt the more flexible profit-sharing plan rather than a money purchase pension plan (including a target benefit plan).