The Money Purchase Pension Plan is an employer-sponsored defined contribution pension plan. It’s a tax-deferred plan and you will have guaranteed retirement income.
Joined a company that offers Money Purchase Pension Plan?
Then this post is entirely for you. Because in this in-depth guideline on the money purchase plan, I am going to cover what is it, how it works, its vesting scheme, pros and cons, distribution rules, and everything related to it. So, stay with me till the end.
What Is A Money Purchase Pension Plan?
A money purchase plan is a pension scheme where employers must contribute a fixed amount every year to the employee’s account. An employer can contribute up to 25% of the yearly income of employees. It is similar to profit-sharing plans.
Money Purchase Plan Example
Suppose Mr. Donut joined a company that offers Money Purchase Plan. His employer contributes 10% of Mr. Donut’s annual income to the Money Purchase Pension Plan.
After retirement, Mr. Donut can use withdraw the money as a lump sum or he can get 10% of his annual salary plus investment benefits each year periodically.
Now, let’s look at how it works.
How Does A Money Purchase Pension Plan Work?
Like other pension schemes, A money purchase pension plan is designed to provide guaranteed retirement benefits to employees. Here’s how it works:
- The employer sets the plan and contributes a percentage of the employee’s annual salary according to company policy each year. The contribution amount is fixed.
- The contributed money is invested in a range of investment options, such as mutual funds or stocks, chosen by the employees with the help of the administration.
- When the employee retires, the money in the plan is used to provide retirement income.
- The employee can withdraw the money as a lump sum after the minimum age without any penalties or they can receive it as periodic payments over their retirement.
- Vested employees can take their account balances with them when they leave the company.
Money Purchase Pension Plan Maximum Contribution
The money purchase pension plan maximum contribution is set up by the IRS each year. For 2022, the maximum contribution limit is 25% of the employee’s annual income or $61,000 maximum.
It can vary depending on the year an employer’s policy. However, an employer can not contribute a minimum limit of 5% of the employee’s annual salary.
An employer, both exceeding or falling short below the limit will be subject to Excise Tax.
Money Purchase Plan Employee Contributions
Money Purchase Plan Employee Contributions are mostly rare. However, some money purchase pension plans allow employee contributions.
On the other hand, employees can choose where to invest contributions from the available options within the plan.
Do Money Purchase Pension Plans Need Vesting?
Yes, money purchase pension plans will require vesting by the employee. Otherwise, employees will take the benefits with them and leave the company.
In case of both retirement or getting fired an employee can take the money purchase plan with him/her if the plan is vested. Meaning the employee has to work for the company for a certain number of years. It might need 5 to 10 years for the plan to be completely vested.
However, the vesting requirement completely depends on your employer’s policy
Money Purchase Pension Plan Early Withdrawal
An employee can start withdrawing from the age of 59 ½ with a 10% tax penalty. However, withdrawal before the age of 59 is also possible in some rare cases. In those cases, the employee has to experience a qualifying event, such as disability, death, or severe health issue.
Money Purchase Pension Plan Distribution Rules
Money Purchase Pension Plan Distribution rules are fairly simple. Generally, an employee can start withdrawing the money purchase pension plan benefits from the age of 72 in 2022. It will be 75 in 2033.
A retiree can choose to take it as
- Monthly or quarterly benefit.
- Lump sum
Is A Money Purchase Plan A Qualified Plan?
Yes, a money purchase pension plan is a qualified plan. Meaning it meets IRS requirements and will get some tax benefits.
A money purchase plan is tax-deferred and the contributions by the employer will be tax-free. Moreover, the investments will grow tax-free. However, when the employee withdraws the money it will be taxed as regular income.
Furthermore, if an employer contributes more or less than the contribution limits then employers will be subject to Excise Tax.
Is A Money Purchase Pension Plan A Defined Benefit Plan?
No, a money purchase plan is a defined contribution plan, not a defined benefit plan.
In a defined benefit plan, the employer promises to pay a specific benefit to the employee in retirement based on certain factors. The employer bears the investment risk and is responsible for ensuring that there are sufficient funds to pay the promised benefits.
However, in a money purchase plan, the employer contributes a fixed amount and does not promise any benefits.
Now let’s look at how the Money purchase pension plan is different from similar plans.
Money Purchase Pension Plan Vs Defined Contribution
|Money Purchase Retirement Plan||Defined Contribution Plan|
|A money purchase pension plan requires the employer to make a contribution each year.||Employers are not required to make contributions each year. But they can choose to.|
|The contributions are mostly employer contributions. Employees don’t require to make contributions||The contributions are a percentage of pre-taxed employee salaries.|
|Contributions are generally tax-deductible for the employer and tax-deferred for the employee.||Contributions are tax-deferred.|
Money Purchase Pension Plan Vs. Profit Sharing Plan
|Money Purchase Retirement Plan||Profit Sharing Plan|
|A money purchase pension plan requires the employer to make a fixed percentage of contribution each year.||On the profit-sharing plan, the employer makes contributions to employees’ accounts depending on the company’s profits.|
|The employer must contribute the specified amount regardless of the company’s profits or losses.||The employer can choose to contribute any amount up to a certain limit each year.|
|Contributions are generally tax-deductible for the employer.||Profit sharing plan contributions are tax-deductible for the employer.|
|The contributions are tax-deferred for the employee.||Contributions are subject to immediate taxation for the employee.|
By now we should have a good idea of the Money Purchase Retirement Plan. So, What are the benefits of money purchase plans? And What are the disadvantages of money purchase plans?
Pros and Cons of Money Purchase Plans
From my personal experience as a financial advisor, I have found the below points to be the pros and cons of the money purchase pension scheme.
- Employees are guaranteed a certain level of retirement income, regardless of the company’s profits or losses.
- Employee contribution is not required.
- It is tax deferred. So the investments made with the amount will grow tax-free.
- Employers can contribute a higher percentage of an employee’s salary to a money purchase plan than they can do to other plans.
- High administrative fees.
- Not flexible for employers.
- The benefits entirely depend on the investment results.
- Vesting is a must.
Overall, a Money purchase plan can be secured and guaranteed pension scheme. Though it’s not up to you if your company offers the money purchase pension plan or not. However, if your employer offers it then try to diversify the investment made with your account. It will make your retirement risk-free.