What is a Money Purchase Pension Plan?
A money purchase pension plan is a kind of retirement plan where employers are needed to make yearly contributions to the accounts of their employees. It provides guaranteed income after retirement. The employees can either withdraw the lump sum amount upon retirement or purchase an annuity with the total amount.
A money purchase pension plan works like a profit-sharing scheme. However, it requires employers to make fixed annual contributions, unlike profit-sharing plans, where annual contributions can be adjusted according to the business’ profitability. Hence, employees receive a fixed percentage contribution regardless of the profits.
A money purchase pension plan and profit-sharing plan can be used together to maximize the yearly allowed contribution levels. Employers usually set up a vesting schedule that governs when the employees can get full ownership of the plan and claim funds from it.
- Money purchase pension plan is offered by some employers as a retirement plan, where fixed contributions are made yearly by the employers.
- The annual contributions made by employers are tax-deferred. Until withdrawn, the funds accumulated are also tax-deferred.
- Employers are not given a choice to add contributions to their accounts. Thus, the retirement savings from a money purchase pension plan may not be enough.
Contribution Limit of Money Purchase Pension Plans
While setting up the money purchase pension plan, employers must state the contribution percentage in the document.
The level of contributions depends on the salary of employees. Employers can contribute a maximum of 100% of each participating employee’s salary or a maximum of 25% of the aggregate yearly compensation of all employees benefiting from the plan or $57,000 (in 2020), whichever is lower.
Money Purchase Pension Plan Eligibility
A money purchase pension plan can be offered by any company regardless of size. Companies may offer it in conjunction with other contribution retirement plans to maximize allowable annual contributions.
The structure of a money purchase pension plan can be simple or complex, depending on the needs of the company. The employer is required to file a Form 5500 yearly with the Internal Revenue Service. This form is the annual return or report of the benefit plan of the employee.
Small-sized companies may take pre-packed plans from authorized retirement plan suppliers. In such cases, the plan provider administers the money purchase pension plan on behalf of the company.
Benefits of a Money Purchase Pension Plan
- Annual contributions made by employers are tax-deferred until the amounts do not go beyond a certain limit. The contributions accumulated in the employees’ funds are also tax-deferred as long as an amount is not withdrawn.
- It guarantees the participating employees a retirement benefit, enabling them to accumulate savings for retirement.
- Companies offering money purchase pension plans get an edge while competing for talented human capital.
- There is no tax penalty on the amounts withdrawn if the employee with full ownership of the plan has reached the age of 59 ½.
- There are certain qualifying events where employees below the age of 59 ½ can borrow funds from their money purchase pension plan. These events are outlined in the plan document.
Drawbacks of a Money Purchase Pension Plan
- It does not allow employees to make contributions to their accounts. Hence, savings made through a money purchase pension plan alone may not be sufficient.
- It does not give employers the flexibility of adjusting the annual contributions according to the profits made by the company. Employers need to make annual contributions even if the business has incurred losses.
- It makes withdrawals mandatory once the employees reach the age of 72. These withdrawals are treated as ordinary income; hence, account holders are required to make tax payments.
- It incurs higher administrative expenses than other defined retirement schemes offered by employers.
CFI is the official provider of the global Commercial Banking & Credit Analyst (CBCA)™ certification program, designed to help anyone become a world-class financial analyst. To keep advancing your career, the additional CFI resources below will be useful: