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 into the account every year, but the employee is not permitted to contribute directly to the fund. However, they can choose how to invest the money based on options offered by the employer.
Key Takeaways
- The money purchase plan provides an annual employer contribution to employees’ retirement savings.
- Employees don’t contribute to this plan but may have additional retirement savings options.
- A money purchase plan is a qualified retirement savings plan where the tax benefits are applied, taxing the money only upon distribution.
Journey of 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:
- When changing employers, you can roll the money over into a 401(k) or an IRA.
- Withdrawing funds before retirement incurs a penalty.
- Employers may choose to authorize loans but not withdrawals from the account.
Contributions to a Money Purchase Plan
Each member’s account balance varies based on the employer’s contribution level and the investment returns. Money purchase plans can accompany profit-sharing plans or exist simultaneously with other retirement plans. In this setup:
- The employer’s contribution is tax-deductible, and the employee’s account balance remains tax-deferred until withdrawal.
- The company must make contributions irrespective of profitability.
- For 2023, the IRS limits contributions to the lesser of 25% of compensation or $66,000.
Employees can start taking out funds at age 59½ without a tax penalty, usually after meeting a vesting period specified by their employer.
Required Minimum Distribution
As with any defined contribution plan, required minimum distributions (RMDs) apply. For 2023, the RMD age is 73, increasing to 75 in 2033.
Balancing the Benefits and Drawbacks
When combined with other plans like a 401(k), the money purchase plan can significantly amplify retirement savings. Companies benefit by offering this program, attracting talent with its favorable tax implications. However, higher administrative costs could be a drawback compared to other retirement plans.
Common Questions Answered
Is a Money Purchase Plan a Defined Contribution Plan?
Yes, it is. 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?
Withdrawals before age 59-1/2 will incur penalties. Post-retirement, funds can be distributed as a lump sum or as an annuity.
Is a Money Purchase Plan an Employer-Sponsored Retirement Plan?
Absolutely. It 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 provides a consistent method for employees to increase their retirement savings, courtesy of employer contributions resembling a corporate profit-sharing program. While adhering to tax regulations and specific guidelines, these plans help employees build a substantial retirement fund, aided by the requirement for minimum distributions after age 59½.
Related Terms: 401(k), IRA, profit-sharing plan, qualified retirement plan, vesting period, required minimum distribution.
References
- Internal Revenue Service. “Money Purchase Plan”.
- U.S. Department of Labor, Employee Benefits Security Administration (EBSA). “What You Should Know About Your Retirement Plan”, Pages 18, 21.
- Internal Revenue Service. “Retirement Topics - Exceptions to Tax on Early Distributions”.
- U.S. Senate, Committee on Finance. “SECURE 2.0 Act of 2022 Summary”, Page 2.
