A money purchase plan is an employee retirement benefit plan that resembles a corporate profit-sharing program. An employer deposits a percentage of a participating employee's salary in the account every year, but the employee is not permitted to contribute to the fund. However, they can choose how to invest the money based on options offered by the employer.
- The money purchase plan is an annual employer contribution to its employees' retirement savings.
- Employees don't contribute to this plan but may opt to have additional retirement savings plans.
- A money purchase plan is a qualified retirement savings plan where the employee does not pay taxes on the money until it is distributed.
Understanding the Money Purchase Plan
A money purchase plan is a qualified retirement plan, eligible for tax benefits and subject to tax regulations. The rules are similar to those for other qualified retirement accounts:
- If you leave your employer, you can roll the money over into a 401(k) or an IRA
- You can't withdraw the funds before retirement without incurring a penalty
- Your employer may authorize loans but not withdrawals from the account
The money purchase plan is designed to provide retirement income. Upon retirement, the total pool of capital in the account can be used to purchase a lifetime annuity or withdrawn in a lump sum.
A money purchase plan may be used in addition to an employee's retirement savings, such as a 401(k).
Contributions to a Money Purchase Plan
The amount in each member's account differs, depending on the employer's level of contributions and the investment return earned on those contributions. Money purchase plans can be used in addition to profit-sharing plans or along with other retirement plans. In a money purchase plan, the employee's account balance is tax-deferred until the money is withdrawn, while the employer's contribution is tax-deductible.
It is similar to a profit-sharing plan, but the company cannot adjust its contribution level to a money purchase plan as profits go up or down. Company contributions must be made whether or not the business makes a profit, or how much profit it makes. For 2023, the overall contribution limits allowed by the IRS are the lesser of 25% of compensation or $66,000.
The participant's benefit at retirement is based on total contributions and the gains or losses on investments. As long as the contribution amounts remain within the annual limits, the money is tax-deferred. Employers typically establish a vesting period after which an employee is eligible for the program. After being fully vested, an employee may start taking out funds at age 59½ without a tax penalty.
Required Minimum Distribution
Like all defined contribution plans, RMDs are required for a money purchase plan. For 2023, the required minimum distribution age is 73 and will increase to 75 in 2033.
Advantages and Disadvantages
The money purchase plan can substantially boost retirement savings if used with other savings plans like a 401(k). For the company, having such a program gives them an edge in competing for talent as the tax benefit levels the expenditure. On the downside, the money purchase plan may have higher administrative costs than other retirement plans.
Is a Money Purchase Plan a Defined Contribution Plan?
A money purchase plan is a defined contribution plan where employer contributions are based on a fixed percentage of an employee's annual compensation or salary.
Can You Withdraw Money From a Money Purchase Plan?
Like other retirement plans, withdraws before age 59 1/2 will incur a penalty. After retirement age, money can be distributed as a lump sum or as an annuity.
Is a Money Purchase Plan an Employer Sponsored Retirement Plan?
A money purchase plan is considered an employer-sponsored retirement plan that requires companies to contribute a specific percentage of an employee's salary each year, regardless of the company's profitability.
The Bottom Line
A money purchase plan is an employee retirement benefit plan that resembles a corporate profit-sharing program where the employer deposits a percentage of a participating employee's salary in the account every year. Like most retirement plans, the money purchase plan requires that employees refrain from distributions before age 59 1/2. The plan also has a provision for required minimum distributions.