What is it?
A money purchase pension plan is a type of qualified defined contribution plan in which you, the employer, make annual required contributions to the accounts of participating employees. The amount of your employer contributions is generally determined based on a preset formula that cannot be changed without amending the plan, even if your business profits are low or nonexistent.
A money purchase pension plan is very similar to a profit-sharing plan. In fact, the two plans are so similar that each type of plan is specifically required to identify itself as either a “money purchase pension plan” or a “profit-sharing plan” in the plan document. The most significant distinction between the two types of plans is the money purchase pension plan’s mandatory fixed contribution formula (in contrast, contributions to a profit-sharing plan are generally discretionary).
Tip: Prior to the Economic Growth and Tax Relief Reconciliation Act of 2001 (“2001 Tax Act”), limits on the tax-deductibility of employer contributions to retirement plans favored money purchase pension plans over profit-sharing plans (employers could deduct up to 25 percent of total compensation for contributions made to a money purchase pension plan, but only up to 15 percent of total compensation for contributions made to a profit-sharing plan). The 2001 Tax Act, however, increased the limitation on tax-deductible contributions to profit-sharing plans to 25 percent. With this change, most employers will find it to their advantage to adopt the more flexible profit-sharing plan rather than a money purchase pension plan.
Caution: From an employee perspective, however, a money purchase pension plan’s mandatory fixed annual contribution is generally seen as an advantage.