What Is a Money Purchase Plan? Definition and Benefits

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.

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 Upon retirement, the total pool of capital in the account can be used to purchase a lifetime annuity or withdrawn in a lump sum.

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 In a money purchase plan, the employee's account balance is tax-deferred until the money is withdrawn, while the employer's contribution is tax-deductible.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.

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.

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.