A money purchase plan is an employer-sponsored retirement plan that requires companies to contribute a specific percentage of an employee’s salary each year, regardless of profitability. Because of this guaranteed contribution, money purchase plans can be attractive options for employers to attract and retain key employees, though they can be pricey for companies to maintain.
What Is a Money Purchase Plan?
Money purchase plans are employer-sponsored, defined-contribution retirement plans, like 401(k)s and 403(b)s. As with other workplace retirement plans, contributions to money purchase plans grow tax-deferred, and employer contributions may be tax-deductible for the employer.
Money purchase plans differ from these more well-known plans in a few key ways:
• Contributions to a money purchase plan are primarily made by the employer, not the employee. Employees can choose how to invest contributions using the plan’s options. Some money purchase plans allow for employee contributions as well. When employee contributions are offered, employees may be required to contribute.
• Contributions to a money purchase plan are fixed on an annual basis. The plan documents state the percentage of an employee’s salary that the employer will contribute to the plan each year. Unlike a profit sharing plan or even certain 401(k) matches, employer contributions don’t change based on how profitable the company was throughout the year.
• Money purchase plans often have vesting schedules. Since the employer bears most or all of the contribution burden, companies want to make sure an employee doesn’t just take a job to rack up the employer contributions and run. A vesting schedule dictates when certain percentages of a money purchase plan will be available to an employee. Vesting is not an uncommon feature even among 401(k) plans, half of which require some amount of vesting for employer contributions.
How Much Can Be Contributed to a Money Purchase Plan?
All employer and employee contributions to money purchase plans are subject to annual limits established by the IRS. For 2023, the limits are the lesser of:
- 25% of the eligible employee’s salary, or
- $66,000 ($69,000 in 2024)
Companies offering any kind of defined contribution plan have to be careful that their plans don’t become top-heavy, favoring highly compensated employees over employees with lower annual salaries.
A plan is considered top-heavy if the company’s owners and highly compensated employees own more than 60% of the money purchase plan’s total assets. If a company is found to have a top-heavy plan, the plan might lose its “qualified plan” status, leaving both the employer and participating employees subject to hefty tax penalties.
Money purchase plans are frequently offered in conjunction with profit sharing or 401(k) plans, but employer contributions are limited to the maximums listed above across all accounts. Employees, on the other hand, can max out their 401(k)s and also receive the maximum employer contribution across their retirement accounts.
How Does a Money Purchase Plan Compare to a 401(k)?
Money purchase plans and 401(k) plans have certain similarities.
“Both require business owners to be extremely efficient with time and money,” says Brian Halbert, a retirement specialist at Pensionmark. “Both plans require quite a bit of administration and record-keeping on behalf of both the employer and employee. Likewise, both are efficient vehicles for employees to save toward retirement.”
Other commonalities include:
Despite the many similarities between money purchase plans and 401(k)s, employers seem to be trending away from offering money purchase plans in favor of their more well-known (and more flexible) counterparts.
“As of now, many employers are opting for 401(k) plans due to two main factors: streamlined technology and administration and lower costs,” says Halbert. “In recent years, the [benefits] industry has seen a truly incredible lowering of total cost within the 401(k) plan market.”
What Are the Benefits of Money Purchase Plans?
For both employers and employees, money purchase plans offer several unique benefits that aren’t found in other types of defined-contribution plans.
“The most advantageous aspect of a money purchase plan is the ‘forced’ savings from the employer,” says Halbert. “By adopting a money purchase plan, the employer is committing to helping the employee save. When used with other plans like a 401(k) or profit sharing plan, the employee can truly save large amounts annually while the employer can boost its talent and culture ranks.”
Money purchase plans may also allow employees to contribute more to their own retirement when used in conjunction with a 401(k). While the same employer cannot contribute more than the lesser of 25% of an employee’s salary or $66,000 in 2023 ($69,000 in 2024), an employee can max out their 401(k) contributions and make more money purchase plans contributions, says Ben Dobler, CFP, an enrolled agent with Stewardship Financial Counsel.
What Are the Disadvantages of Money Purchase Plans?
The biggest drawback of money purchase plans is for employers. Money purchase plans require employers to contribute a set percentage of their employees’ salaries every year, regardless of how they perform. This, in conjunction with comparatively higher administrative costs, can make money purchase plans more expensive than other defined-contribution plans.
For employees, the biggest drawback of a money purchase plan is the potential they may be required to contribute a certain percentage of their salary, depending on their employer’s plan. This could deter prospective talent uncomfortable with mandatory plan participation.
“For-profit businesses wanting more flexibility with contributions to employees’ retirement accounts often choose to offer 401(k) plans instead, which allow employer contributions but do not require them,” says Dobler.
The Bottom Line on Money Purchase Plans
As an employee, you probably won’t choose to work at a company solely because it does or doesn’t offer a money purchase plan. You’ll probably weigh company culture, career opportunities and other retirement account availability over a money purchase plan offering. That said, these plans can be powerful incentives to choose one company over another, all else being the same, and money purchase plans can add strength to your retirement savings plan.
As an employer, you might consider offering a money purchase plan if you’re a for-profit company and trying to keep a particular industry’s top talent. If you can withstand the additional administrative costs and contribution minimums, money purchase plans are definitely worth considering for your benefits portfolio.
