What are target benefit plans?
Simply put, target benefit plans (TBPs) are a unique type of pension plan that blend elements of defined-benefit and defined-contribution plans to provide a base monthly pension at retirement (which may be allowed to change, depending on the pension plan’s performance) with limited or conditional indexation. The benefits paid in retirement are linked with how well the pension plan performs. Target benefit plans are similar to jointly-sponsored or multi-employer pension plans, where a number of employers (usually within the same industry) share a pension plan.
Target benefit plans shift the concept of risk. With defined-benefit pensions, the employer or plan sponsor is usually wholly responsible to ensure the pension promise is fulfilled. The employer and to some extent active employees are responsible for making up pension funding shortfalls, through their contributions and the plan’s investments. With defined-contribution plans, employees bear all of the risk – their contributions are known, but the benefit they will receive in retirement is not. By linking the pension benefit and indexing with plan performance, and allowing benefit reductions, retirees become partially responsible for making-up plan funding shortfalls.
Target benefit plans offer pooling of assets between employees and economies of scale, and funds are generally managed in much the same way as in a defined-benefit plan – although target benefit plans may be invested more conservatively to protect against the chances of a funding deficit.
Usually, target benefit plan provisions in pension legislation allow new target benefit plans to be set up, or for employers or plan sponsors to convert from a defined-benefit or defined-contribution plan to a target benefit plan.