Target Benefit Plan
A target benefit plan is a hybrid employer retirement plan that combines elements of defined benefit and defined contribution structures — employer contributions are calculated using actuarial assumptions to target a specific retirement income, but investment risk is borne by the employee and actual benefits depend on account performance.
Target benefit plans occupy an unusual middle ground in the employer retirement landscape between pure defined contribution plans (like 401(k)s) and pure defined benefit pension plans. Understanding the distinction requires clarity on what each structure guarantees. A defined benefit plan guarantees a specific monthly benefit regardless of investment outcomes — the employer assumes investment risk. A defined contribution plan specifies only what goes in, not what comes out — the employee bears investment risk. A target benefit plan specifies what the employer contributes (calculated actuarially to aim for a target retirement income) but does not guarantee that the target will be achieved.
Actuarial formulas drive the contribution calculation. The employer chooses a benefit target — for example, 50% of final average salary at age 65 — and an actuary calculates the annual contribution needed, given assumed rates of return, expected salary growth, and mortality tables. Each year the employer makes that contribution for each participant. But if investments underperform or market conditions shift, the employee's actual account balance may fall short of the original income target, with no mechanism for the employer to make up the shortfall.
Target benefit plans are far less common than either defined benefit pensions or 401(k) plans. They were more prevalent before the widespread adoption of 401(k)s and are now found primarily in collectively bargained multiemployer situations, some professional corporation arrangements (particularly for owner-employees in small medical or legal practices), and certain state and local government contexts.
The advantage for employers is contribution predictability and the absence of pension liability risk. Unlike a defined benefit plan, the employer has no obligation to fund benefit shortfalls. The advantage for employees over a plain defined contribution plan is that the contribution formula is tied to compensation and actuarial benefit objectives, potentially generating higher employer contributions for older employees closer to retirement who need larger contributions to catch up.
Plan participants in target benefit arrangements should understand clearly that the income target is illustrative rather than contractual. Monitoring investment performance and adjusting personal savings or spending expectations as needed is essential, since no backstop exists if the account falls short.