Here's an example of how a target benefit plan might work in a two-owner company with three employees. Here's some general information about the Smith-Jones Corporation and its employees and owners:
| Smith-Jones Corporation Census | |||
|---|---|---|---|
| Name of employees | Age |
Years of Service |
Annual Compensation |
| Owner Smith | 50 | 25 | $60,000 |
| Owner Jones | 49 | 25 | $60,000 |
| Joe Employee | 30 | 5 | $35,000 |
| Jim Employee | 27 | 4 | $30,000 |
| June Employee | 26 | 3 | $27,000 |
To illustrate the owners' advantage in having a target benefit plan, let's see how a straight profit-sharing plan would serve its participants at the Smith-Jones Corporation. Let's assume a straight profit-sharing plan where 15 percent of compensation is contributed for each employee.
| Smith-Jones Corporation Profit-Sharing Proposal- 15 percent of Individual Compensation |
||
|---|---|---|
| Name of Employee |
Contribution Amount |
Percentage of Plan's Total Contribution |
| Owner Smith | 9,000 | 28.3 |
| Owner Jones | 9,000 | 28.3 |
| Joe Employee | 5,250 | 16.5 |
| Jim Employee | 4,500 | 14.1 |
| June Employee | 4,050 | 12.7 |
In the straight profit-sharing plan, the amount of the plan's total contribution is allocated by a percentage that is calculated by dividing each employee's individual contribution by the total amount of contributions (for Owner Smith, the percentage is 9,000 divided by 31,800 = 28.3 percent). There is no advantage unless you contribute more for each employee.
Now let's assume a target benefit plan that weighs age and service in determining contributions.
| Smith-Jones Corporation Target Benefit Plan | ||
|---|---|---|
| Name of Employee |
Contribution Amount |
Percentage of Plan's Total Contribution |
| Owner Smith | 13,000 | 40.8 |
| Owner Jones | 13,000 | 39.3 |
| Joe Employee | 2,700 | 8.5 |
| Jim Employee | 2,200 | 6.9 |
| June Employee | 1,400 | 4.4 |
As you can see from the example above, a much greater portion of the total contribution (80 percent compared to 56 percent) is shifted to the business owners in a plan that considers owners' higher ages and longer service. Determining the formula is something that your financial advisor can help you with.
As you consider this option, be sure you understand the disadvantages
of target plans.