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Target Benefit Pension Plan

The Basics: The target benefit plan has elements of both the defined benefit and defined contribution plans. The contributions are determined as if the plan were a defined benefit plan, while the defined contribution plan annual contribution percentage and dollar amount limitations apply to the actual contributions made on behalf of each participant. With the introduction of age-weighted and cross-tested defined contribution plans, target benefit plans are rarely adopted.

How It Works
    1. Employer contributes an actuarially determined amount each year subject to percentage and dollar limitations to the plan.
    2. Employer contributions are tax deductible. IRC Sec. 404(a)
    3. Contributions not taxed currently to the employee. IRC Secs. 402(a) and 403(a)
    4. Earnings accumulate income tax-deferred. IRC Sec. SO 1(a)
    5. Distributions can be tax-favored (eligible for year forward averaging or rolled over into an IRA) at
      retirement. IRC Sees. 402 and 403

Methods Of Defining The Benefit

Level Percentage Plan: Example. The benefit is equal to 50% of compensation, reduced by 1/25 for each year of participation less than 25.

Yearly Accrual: Example; The benefit is equal to 5.0% of compensation for each year of participation.

Top-Heavy Plan: If more than 60% of the plan assets are allocated to "key employees," the employer must contribute at least as much for participants as it does for key employees. This requirement applies only to a contribution of up to the first 3% of includable compensation (higher in some instances).

Additional Considerations
    1. Contribution Limitations: The employer contributes an amount actuarially determined but not wore than the lesser of 25% of includable compensation or $30,000 annually for each participant.
    2. Parties which are Favored: The target benefit plan favors older ernployees. A company with principals and key workers older than the rank and file should consider a target plan.
    3. Investment of Plan Assets: Investments must be diversified and prudent. Subject to plan provisions; plan assets can be invested in equity products like mutual funds; stocks and debt free real estate; or in debt instruments like T-Bills and CDs. Insurance products like life insurance and annuity policies may also be used.
    4. Social Security Integration: Since the employer already contributes to the employees Social Security retirement benefit, these contributions can be integrated into 'he benefit formula of the plan.

How Much Will There Be At Retirement?

This will depend upon three factors:

  • A. The amount of contributions

  • B. The number or years until retirement

  • C. The investment return.

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    The risk of poor investment returns rests upon the employee. However, if the investment results are favorable, the participant will have a larger fund at retirement age.

    Advantages To Employer

  • A. Contributions are tax deductible.

  • B. Contributions will rise as compensation rises, but they are controllable both by formula and absolute dollar amounts.

  • C. Forfeitures of terminating employees may reduce future costs.

  • D. It can provide employees with permanent life insurance benefits that need not expire or require costly conversion at retirement age.

  • E. The employer directs investments.

  • F. Often the advantages of a defined benefit plan can be obtained without its problems.

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    Advantages To Employees

  • A. Annual contributions are not taxed to the participant.

  • B. Earnings on the account are not currently taxed.

  • C. Distributions at retirement may be tax-favored.

  • D. Participants may 'be given the right to direct investments.

  • E. Participants can also have a traditional7 deductible IRA, or a Roth IRA, subject to certain income level limitations based on filing status.

  • F There is the ability to purchase significant permanent life insurance which is not contingent upon the company group insurance program. Purchase of life insurance will generate taxable income to the employee (PS 58).

  • G. Employees can accumulate a larger fund than with a defined benefit plan , if actual investment return exceeds the assumed rate of return, which must be between 7.5% & 8.5%.

  • H. Employees can borrow from the plan within certain legal guidelines, if provided for in the plan documents.

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    Disadvantages To Employer

  • A. In low profit years, the employer is still obligated to wake contributions.

  • B. There is no flexibility with the level of contributions.

  • C. In some cases, the target benefit plan may not produce as large of a contribution and deduction for older employees as a defined benefit plan might.

  • D. Since these plans are so rare, it may be difficult to find a plan administrator.

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    Disadvantages To Employees

  • A. There is no guarantee as to future benefits.

  • B. Investment risks rest on the participant.

  • C. Older participants may not receive as great of a benefit as with a defined benefit plan.

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