Money Purchase Retirement Plans
What is a money purchase plan?
A money purchase plan is a defined contribution plan, like a profit-sharing plan. The main difference is that the contribution amount defined in the plan document is a required contribution; the employer must contribute the required contribution amount on time or pay penalties to the IRS.
The amount of required contribution is usually defined in the plan document as a percentage of each employee’s compensation. For example, the contribution amount could be defined as 10 percent. This would mean that the employer must contribute 10 percent of each employee’s eligible compensation each year. The amount of compensation to use (the eligible compensation) in the calculation would also be defined in the plan document. If an employee’s eligible compensation were $40,000 for a given year, and the contribution were defined as 10 percent, the employer would be required to contribute $4,000 to the plan’s trust account on behalf of that employee for that year.
What are the benefits of a money purchase plan?
The main benefit of a money purchase plan is that employees are guaranteed a set contribution each year on behalf of their employer.
Money purchase plans are rarely used because similar contribution amounts can be achieved in a profit-sharing plan with discretionary contributions each year. There needs to be a special reason for the employer to commit to the requirements of a money purchase plan.
Who may establish a money purchase plan?
Any employer is eligible to establish a money purchase plan.
Who may participate in a money purchase plan?
Both employers and employees may participate in this plan.
How is a money purchase plan established?
- Adopt a written plan, called the plan document, which outlines its day-to-day operations.
- Identify a plan provider and/or trust for the plan’s assets and investments.
- Select a recordkeeper or recordkeeping system to track contributions, earnings and losses, and distributions. This person or entity will also help prepare the annual return, which must be filed with the federal government.
- Select a third party administrator to maintain the plan document, fulfill daily tasks and ensure compliance with federal regulations. Your financial advisor may choose a third-party administrator and/or recordkeeper on your behalf.
- Provide eligible employees, or plan participants, with a summary plan document (SPD), which is the document that outlines who can participate and how the plan works.
The written plan also provides a central document, or collection of documents, which explains the rights of the employees and employee eligibility for participating in the plan and enables government agencies to determine whether it satisfies applicable laws.
If the plan allocates responsibilities for performing administrative functions to other parties, such allocation must identify who is responsible for ensuring compliance with the requirements of the tax code, including compliance requirements for loans and distributions.
In the case of funding through multiple financial institutions, the employer may adopt a single written plan to coordinate administration among the financial institutions, rather than having a separate document for each issuer.