What is a 'Money-Purchase Pension Plan'
A money-purchase pension plan is a pension plan to which employers and employees make contributions based on a percentage of annual earnings, in accordance with the terms of the plan. Upon retirement, the total pool of capital in the member's account can be used to purchase a lifetime annuity. The amount in each money-purchase plan member's account differs from one member to the next, depending on the level of contributions and the investment return earned on such contributions.
BREAKING DOWN 'Money-Purchase Pension Plan'With a money-purchase pension plan, an employee and/or employer makes annual contributions according to the required percentage. For example, a plan with a contribution of 5% of each eligible employee’s pay means the employer contributes 5% of each eligible employee’s pay to his separate account annually. Contributions must be made whether or not the business makes a profit. In 2016, subject to cost-of-living adjustments, the overall contribution limits are 25% of an employee’s compensation or $53,000, whichever is less. The plan may be used along with profit-sharing plans for maximizing annual contribution amounts. The amount of contributions and gains or losses of an account after an employee retires determines a participant’s benefit.
Characteristics of a Money-Purchase Pension Plan
An employee with a money-purchase pension plan may work for a company of any size, participate in additional retirement plans, or contribute to other retirement accounts. Although loans to participants are allowed for qualifying events outlined in the contract, in-service withdrawals are not allowed. Each employee must file a Form 5500 with the Internal Revenue Service (IRS) annually.
As long as contribution amounts remain within annual limits, employer contributions and employee funds remain tax-deferred. Although employees may not contribute additional funds to their accounts, they typically may choose the funds in which to invest their money.
Employers typically declare vesting schedules showing when an employee may withdraw funds from his plan. After being fully vested, an employee may start taking out funds at age 59 ½ without a tax penalty. Withdrawals as a lump sum or as minimum annual installments based on life expectancy are taxed as ordinary income and must start by the time the account owner reaches age 70 ½.
Pros and Cons of a Money-Purchase Pension Plan
With a money-purchase pension plan, participants may be able to retire with greater savings than with other retirement plans. However, the plan may have greater administrative costs than other retirement plans. Also, if the minimum plan contribution is not deposited, an excise tax is incurred. In addition, a money-purchase pension plan must be tested to ensure employees with greater compensation are not favored over other employees.