Disadvantages of Target Plans

There are a couple of drawbacks to a target plan. One major drawback is its tendency to backload benefits. While defined benefit plans typically take into account future salary increases in their funding (thus spreading their effect over many years), target benefit plans do not recognize future salary increases in advance.

Accordingly, contributions to target benefit plans can rise sharply as the age and salary levels of participants increase. A steep increase results from the plan's method of calculating contributions that requires that each increase be funded over successively shorter time periods. In other words, because years of service and generally a person's salary (and consequently their contribution amount) go up, the fund has to make up a lot of ground as the person draws closer to retirement age. This is definitely something to consider if you employ or plan to employ young, professional people who may stay with your business for a long time.

On the bright side, when the backloading effect of the target benefit plan is carefully communicated to employees, it can be a powerful incentive for individuals to delay retirement or continue employment.