What Is a Money Purchase Plan? Everything You Need To Know

An employer-sponsored retirement plan known as a money buy plan mandates annual contributions from employers equal to a certain proportion of an employee's income, regardless of the company's level of profitability. Because of this guaranteed contribution, money purchase plans have the potential to be appealing solutions for employers looking to recruit and keep important personnel, even though maintaining these programs may be expensive for businesses. In the next section, we will discuss how money purchase plans work, which is eligible to have one, as well as the benefits and drawbacks of these retirement plans.

How It Work

Money purchase plans can be made available to employees of businesses of any size. These plans may be provided to participants on their own or in conjunction with various other retirement plan options.

The Characteristics of a Money Purchase Plan

Although employers are required to contribute to a money purchase plan on an annual basis for each employee who is a participant in the plan, employee contributions are not permitted by all plans. Yet, if workers have the opportunity to make contributions, they are not obligated to do so; however, doing so may be an effective strategy to save money for retirement. Depending on the company's requirements, money buy programs may be made simple or complex. The only thing that is required for an employer to do to establish a plan is to submit Form 5500, which is known as the "Average Return and Statement of Employee Benefit Plan," to the Internal Revenue Service (IRS) on an annual basis.

Smaller organizations may likely benefit from having a qualified retirement plan provider set them up with a pre-packaged money purchase plan that the provider would then manage on their behalf. This would allow the provider to take care of the plan's administration on their behalf.

Pros

Tax advantages

The business may claim a tax deduction for contributions made to money purchase plans, and workers can postpone paying taxes on such contributions. The growth of investments is not subject to taxation until the money is taken upon retirement. The amount that an employer may deduct for contributions to a money purchase plan cannot exceed 25 percent of the total income that qualified plan participants receive or earn.

Bigger account balances

The fact that the employer is obligated to contribute implies that money will be deposited into the accounts of each employee on an annual basis. Contributions made throughout time have the potential to accumulate into a sizeable nest egg.

Regular payments

Money purchase plans are obliged to provide workers a continuous value in the form of a life annuity, which is normally distributed as a monthly benefit throughout your lifetime. This benefit is paid out throughout your working life. They also have the choice of many different payment options to choose from.

Incentives for employment

Employees have the chance to save money via the use of money purchase plans, which may be an attractive selling feature in today's highly competitive labor market. Because donating a portion of an employee's wages to their retirement may assist foster goodwill while also increasing their savings, businesses that provide money purchase plans can give the advantage to both newly hired workers and those who have been with the company for a while.

Cons

Administrative expenses

The costs associated with defined contribution programs are often more costly than the fees associated with simpler defined contribution plans.

Top-heavy evaluation

You may lose the status of having a qualifying plan as well as the tax advantages that come along with having such a plan if it seems that the plan favors persons who earn more money.

Needed contributions

Due to the necessary contribution rate, companies are obligated to make contributions even when their earnings are low. This may place a financial strain on a company when it is already struggling to make ends meet.

Excise tax

An excise tax will need to be paid by a firm if they do not have the necessary money in their bank account.

The Bottom Line

If you are an employee, the presence or absence of a money purchase plan is unlikely to be the deciding factor in your decision to work for a certain firm. A money purchase plan may not be as important to you as the organization's culture, the prospects for professional advancement, and the variety of available retirement accounts. These plans can be significant incentives to select one firm over another, provided that everything else is equal, and money buy programs have the potential to add strength to your retirement savings plan.