What Is a Money Purchase Plan & How Does It Work?

A Money Purchase Plan is a type of employer-sponsored retirement plan designed to help employees save for their future. It operates as a qualified plan, adhering to Internal Revenue Service (IRS) regulations and providing tax advantages. This structure allows employer contributions to grow tax-deferred until funds are withdrawn in retirement. The plan serves as a vehicle for employers to provide a predictable and consistent retirement benefit to their workforce.

Key Characteristics of a Money Purchase Plan

A Money Purchase Plan functions as a defined contribution plan, where contributions are set, and the eventual retirement benefit depends on total contributions and investment performance. Unlike some other plans, employer contributions are fixed, typically a specific percentage of an employee’s annual compensation. For instance, the plan document might require an employer to contribute 5% of each eligible employee’s pay annually, regardless of company profitability.

The annual contribution limit for Money Purchase Plans is substantial, allowing for significant retirement savings. For 2025, the maximum contribution limit for an employee’s account is the lesser of $70,000 or 25% of the employee’s compensation. Employer contributions are tax-deductible for the business, and the funds grow on a tax-deferred basis for the employee. While employer contributions are mandated, some plans permit employees to make their own contributions.

Vesting schedules dictate when an employee gains full ownership of the employer’s contributions to their account. Common vesting methods include “cliff vesting,” where full ownership is granted after a specific period, such as three years of service, or “graded vesting,” where ownership increases incrementally over several years. If an employee leaves before becoming fully vested, the non-vested portion of the employer contributions may be forfeited and used to reduce future employer contributions for remaining participants. Employee contributions, if permitted, are always immediately 100% vested.

Participants can typically begin taking penalty-free withdrawals upon reaching age 59½. Withdrawals made before this age are subject to ordinary income tax on the distributed amount and an additional 10% early withdrawal penalty. Funds can be rolled over into another qualified retirement plan or an Individual Retirement Account (IRA) upon termination of employment.

Upon retirement, participants can receive benefits as a lump sum or as an annuity, providing a stream of payments over their lifetime. Required Minimum Distributions (RMDs) must begin when the account holder reaches age 73 (or age 75 if age 73 is reached after December 31, 2032). While loans from the plan may be permitted, in-service withdrawals (withdrawals while still employed before retirement age) are not allowed, unlike some other defined contribution plans.

Establishing a Money Purchase Plan

Establishing a Money Purchase Plan requires adherence to legal and regulatory requirements to ensure its qualified status with the IRS. The initial step involves creating a formal written plan document, which outlines the plan’s terms, including eligibility criteria for employees, the employer’s contribution formula, and vesting schedules. Consulting with legal counsel or a financial advisor is often necessary to ensure compliance with the Employee Retirement Income Security Act of 1974 (ERISA) and the Internal Revenue Code.

Once the plan document is prepared, a trust must be established to hold the plan’s assets separately from the employer’s business assets. This trust owns the contributions and earnings, protecting them for participants. Selecting a trustee (individual, trust company, or financial institution) is important, as they have a fiduciary duty to manage assets prudently.

Employers are also required to formally adopt the plan and provide eligible employees with notice of its establishment. This notification typically includes a Summary Plan Description (SPD), explaining the plan’s provisions, participant rights, and responsibilities. The SPD informs employees about eligibility and enrollment. This initial setup phase focuses on putting the foundational legal and structural elements in place before the plan becomes operational and contributions begin.

Administering a Money Purchase Plan

After a Money Purchase Plan is established, ongoing administration involves several responsibilities for the plan sponsor. A primary task is the accurate calculation and timely deposit of the mandatory employer contributions, made annually according to the fixed percentage defined in the plan document. Contributions are credited to individual accounts, and the employer must ensure adherence to the annual contribution limits set by the IRS.

Annual reporting to federal agencies is a significant administrative duty. Plan sponsors are required to file Form 5500, “Annual Return/Report of Employee Benefit Plan,” with the Department of Labor and the IRS each year. This form provides detailed information about the plan’s financial condition, investments, and operations. The filing deadline for Form 5500 is typically the last day of the seventh month after the plan year ends, often July 31 for calendar-year plans, though extensions may be available.

Managing participant accounts involves overseeing investment options and maintaining accurate record-keeping. While employees often have the ability to direct the investment of their own account balances from a selection of choices offered by the plan, the plan administrator is responsible for ensuring these options are prudent and for keeping detailed records of contributions, earnings, losses, and distributions for each participant. When participants become eligible for distributions, such as upon retirement or termination of employment, the plan administrator processes these payouts in accordance with the plan document and applicable tax laws.