Glossary term
Money Purchase Plan
A money purchase plan is a defined contribution retirement plan that requires the employer to make set contributions under the plan formula.
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What Is a Money Purchase Plan?
A money purchase plan is a defined contribution retirement plan that requires employer contributions according to a set formula. Unlike a discretionary profit-sharing plan, the employer generally must make the required contribution whether or not the business had a strong year.
The plan can be useful for some businesses that want predictable retirement contributions, but it carries more administrative responsibility than simpler workplace retirement options.
Key Takeaways
- A money purchase plan requires fixed employer contributions under the plan document.
- Participants have individual accounts, similar to other defined contribution plans.
- The employer usually files Form 5500 and must follow nondiscrimination and funding rules.
- Missing a required contribution can trigger tax consequences.
How Contributions Work
The plan document states the contribution formula, such as a percentage of eligible compensation. If the formula requires a 10% employer contribution, the employer is expected to contribute that amount for eligible participants under the plan rules. The account balance then depends on contributions, investment performance, fees, and distributions.
Feature | Money Purchase Plan | Profit-Sharing Plan |
|---|---|---|
Employer contribution | Required by formula. | Often discretionary. |
Account type | Individual participant accounts. | Individual participant accounts. |
Business flexibility | Lower, because contributions are required. | Higher, because contributions may vary. |
Administration | Formal plan rules and filings. | Formal plan rules and filings. |
Employer Commitment
The main planning issue is the required contribution. A business with uneven cash flow may find the obligation restrictive during weak years. If the required minimum contribution is not made, the employer may face excise taxes or other correction requirements.
For employees, the set contribution formula can be attractive because it creates a clearer funding expectation than a purely discretionary plan. The tradeoff is that investment results and account balances are still not guaranteed.
Because contributions are tied to the plan formula, the design needs to be realistic before the plan is adopted. A generous formula can build meaningful retirement balances, but it can also become a cash-flow obligation the employer has to fund during slower business periods.
Where It Fits
Money purchase plans are less common than some simpler options, but they remain part of the retirement-plan toolkit. A business considering one should compare it with a 401(k), profit-sharing plan, SEP IRA, SIMPLE IRA, or defined benefit plan based on contribution goals, payroll, administrative cost, and cash-flow stability.
The Bottom Line
A money purchase plan is a defined contribution plan with a required employer funding formula. Its strength is contribution discipline; its drawback is reduced flexibility when business cash flow changes.