• A money purchase pension plan is an employer‑sponsored, tax‑advantaged retirement plan in which the employer must contribute a fixed percentage of each participating employee’s salary each year. Employees may also be allowed to contribute and choose investments from employer‑provided options.
– Employer contributions are tax‑deductible; participant account balances grow tax‑deferred until distributed.
– Contributions are mandatory from the employer (unlike profit‑sharing plans) and are subject to annual IRS limits: for 2024 the combined contribution limit is $69,000 or 25% of compensation (whichever is less); for 2025 it is $70,000 or 25% of compensation (whichever is less).
– Normal distributions after age 59½ avoid the 10% early‑withdrawal penalty; required minimum distributions (RMDs) apply (age 73 in 2024; scheduled to rise to age 75 in 2033 under recent law).
Sources: Investopedia; IRS; U.S. Department of Labor; SECURE 2.0 Act summary.
Understanding Money Purchase Plans
What it is
– A money purchase plan is a defined contribution retirement plan that requires the employer to make annual contributions to each eligible participant’s account based on a fixed percentage of the participant’s compensation (for example, 5% of pay).
– The participant’s eventual retirement benefit equals the total contributions (employer + any employee contributions) plus or minus the investment gains or losses on the account.
How it differs from profit‑sharing and other plans
– In a profit‑sharing plan, employer contributions can vary by year; in a money purchase plan they must follow the stated formula regardless of business profitability.
– Like other defined contribution plans (401(k), 403(b)), investment risk and ultimate benefit depend on contributions and investment performance, not a promised lifetime payout from the employer.
Important
– Employer contributions are generally required each year (per plan terms); employers cannot reduce contributions when profits fall unless the plan document allows it or the plan is amended prospectively in accordance with plan rules and law.
– Employee account balances are tax‑deferred until withdrawal; contributions made by employers are deductible by the employer.
– Plans typically impose vesting schedules; only vested amounts belong to the employee if they leave before full vesting.
– Early withdrawals (before age 59½) generally incur ordinary income tax plus a 10% additional tax unless an exception applies.
– RMD rules apply. (RMD age: 73 for 2024; set to increase to 75 in 2033.)
Contributions to a money purchase plan
– Employer contribution: fixed percentage of compensation as specified by the plan (e.g., 7% of pay for all eligible participants).
– Employee contribution: allowed only if the plan permits elective deferrals; some money purchase plans let employees make contributions, others do not.
– Annual limits: For tax year 2024, total contributions to a participant’s account (employer + employee) cannot exceed $69,000 or 25% of the participant’s compensation, whichever is less. For 2025 the limit is $70,000 or 25% of compensation. These limits are set by the IRS and are adjusted periodically for cost‑of‑living changes. (IRS adjustments; SECURE 2.0 summary.)
Example
– Employee compensation = $100,000; 25% = $25,000. 2024 dollar cap is $69,000, so the 25% test (25,000) controls: total contributions cannot exceed $25,000 that year for that employee.
Required minimum distribution (RMD)
– Money purchase plans are subject to RMD rules. Account owners must begin taking minimum distributions when required by law (age 73 for 2024; rising to age 75 in 2033). RMD amounts are calculated using IRS life‑expectancy tables and account balances.
– Failure to take RMDs can result in a significant excise tax on the amount not distributed.
What are the pros and cons of a money purchase plan?
Pros
– Employer commitment: fixed annual employer contributions help employees accumulate predictable retirement savings (useful for workers who want steady plan funding).
– Tax advantages: employer contributions generally deductible; participant growth is tax‑deferred until distribution.
– Competitive benefit: offering a generous employer contribution can help recruit and retain employees.
Cons
– Employer cost: mandatory annual contributions can be a financial burden in years with low earnings or cash flow strain.
– Administrative complexity and cost: plan setup, annual funding, compliance testing, and reporting can be more expensive and time‑consuming than simpler plans.
– Employee investment risk: benefits depend on account investment performance; not a guaranteed lifetime payout unless integrated with an annuity.
– Less flexibility for the employer compared with profit‑sharing plans, which can vary contributions by year.
Is a money purchase plan a defined contribution plan?
Yes. A money purchase plan is a type of defined contribution plan. The employer’s obligation is defined (a fixed percentage of pay), but the final benefit depends on contributions plus investment returns. There is no promise of a specified monthly pension amount at retirement (that would be a defined benefit plan).
Can you withdraw money from a money purchase plan?
– Withdrawals in retirement: distributions after age 59½ are generally taxable as ordinary income but not subject to the 10% early‑distribution penalty.
– Early withdrawals: distributions before 59½ are generally taxed as ordinary income and subject to a 10% additional tax unless an exception applies (e.g., certain hardship, disability, or other IRS exceptions).
– Separation from service: if an employee leaves the employer, they can typically roll over the vested plan balance to an IRA or another employer plan, take a lump sum (taxable), or begin distributions subject to plan rules.
– Required minimum distributions apply when the participant reaches the required age.
What is the contribution limit for a money purchase plan?
– 2024: $69,000 or 25% of compensation, whichever is less (IRS).
– 2025: $70,000 or 25% of compensation, whichever is less (IRS adjustments).
Note: The combination of employer and employee contributions cannot exceed these limits; special rules (e.g., compensation definition, allocation method) may affect limits for highly compensated employees and testing requirements.
The bottom line
A money purchase pension plan is a defined contribution vehicle that guarantees employer funding at a fixed percentage of pay. This can be an excellent way for employees to build retirement savings with predictable employer contributions and tax advantages, but it creates a firm recurring cost for employers and can bring higher administrative burdens than some alternatives. Whether it’s the right option depends on employer cash‑flow, desired generosity, and administrative capacity. As with any retirement plan decision, employers and employees should consult qualified tax and benefits professionals for plan design, compliance, and tax consequences.
Practical steps
For employers (setting up and managing a money purchase plan)
1. Assess affordability and objectives: determine the fixed percentage of compensation the company can commit to each year and consider cash‑flow scenarios.
2. Consult retirement plan counsel and a third‑party administrator (TPA): ensure plan documents, vesting schedules, nondiscrimination testing, and funding procedures comply with ERISA and IRS rules.
3. Draft the plan document: include employer contribution formula, eligibility and vesting rules, allowable employee contributions (if any), distribution and rollover procedures.
4. Select investments and a record‑keeper: offer a suitable menu of investment options and set up recordkeeping for participant accounts.
5. Establish payroll and funding procedures: create systems to calculate and deposit employer contributions timely and in compliance with plan terms.
6. Communicate to employees: explain eligibility, vesting, investment choices, withdrawal rules, and rollover options.
7. Maintain compliance: file Form 5500 (as required), perform testing, and adjust the plan only through proper amendment procedures.
For employees (participating and managing money in the plan)
1. Confirm eligibility and vesting schedule: know when employer contributions become nonforfeitable.
2. Understand investment options and fees: review the plan’s investment choices, historical performance, and fee structure.
3. Contribute if allowed and appropriate: if the plan permits employee contributions and your employer matches or contributes, take advantage of it.
4. Track total contributions vs. limits: be aware of the annual IRS dollar/percentage limits (2024 and 2025 figures) to avoid excess contributions.
5. Keep records for rollovers: if changing jobs, consider rolling vested balances into an IRA or new employer plan to maintain tax deferral and investment continuity.
6. Plan distributions and RMDs: before retirement, plan how to take distributions (lump sum vs periodic), understand tax impacts, and comply with RMD rules when age‑appropriate.
7. Seek advice: for tax‑efficient withdrawal strategies and estate considerations, consult a tax advisor or financial planner.
References and further reading
– Investopedia: Money Purchase Pension Plan (source provided)
– Internal Revenue Service (IRS): Choosing a Retirement Plan: Money Purchase Plan
– IRS: Retirement Topics—Exceptions to Tax on Early Distributions
– IRS: 2025 Adjustments Relating to Retirement Plans and IRAs (cost‑of‑living adjustments)
– U.S. Department of Labor, Employee Benefits Security Administration: What You Should Know About Your Retirement Plan
– U.S. Senate Committee on Finance: SECURE 2.0 Act of 2022 Summary
Editor’s note: The following topics are reserved for upcoming updates and will be expanded with detailed examples and datasets.