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 into the account every year. This plan is a type of defined contribution plan, meaning the employee’s benefits hinge on the contributions made to the plan and the investment performance of the plan’s assets.
Key Characteristics
Defined Contribution
In a money purchase plan, the contributions are defined, but the final benefit amount available at retirement is not. The employer agrees to make annual contributions that are usually a fixed percentage of the employee’s salary.
Employer Contributions
Employers are required to contribute to the plan each year, and the amount must comply with the plan’s rules and the contributions are not discretionary.
Special Considerations
Vesting Schedules
Like other retirement plans, money purchase plans can include a vesting schedule, determining the employee’s ownership of the employer contributions over time.
Contribution Limits
The IRS establishes annual contribution limits for defined contribution plans, adjusting them periodically to account for inflation.
Benefits of a Money Purchase Plan
Predictable Contributions
The fixed nature of the employer contributions provides predictability, which can aid in financial planning both for businesses and employees.
Tax Advantages
Contributions are typically tax-deductible for employers, and employees do not pay taxes on contributions until they receive distributions in retirement.
Examples and Applicability
Suppose an employee earns $50,000 annually, and their employer commits to contributing 10% of the salary to the money purchase plan. The employer would deposit $5,000 into the plan annually.
Historical Context
Originally introduced to offer a predictable and systematic way of saving for retirement, money purchase plans gained traction in the late 20th century. They became less common with the rise of more flexible retirement options like 401(k) plans.
Related Terms
- 401(k) Plan: A retirement savings plan sponsored by an employer allowing workers to save and invest a piece of their paycheck before taxes are taken out.
- Profit-Sharing Plan: A plan that gives employees a share in the profits of the company.
FAQs
How is a money purchase plan different from a 401(k)?
When can employees withdraw from a money purchase plan?
Summary
A Money Purchase Plan serves as a structured retirement savings avenue benefiting both employees and employers. By mandating employer contributions, it ensures a steady stream of investment into the employee’s retirement fund, with favorable tax implications and predictable funding levels. Although less prevalent today, understanding its intricacies can aid in comprehensive retirement planning.
