Are you trying to figure out how to save money for retirement? If so, then money purchase plans may be the right option for you. Money purchase retirement plans offer a number of benefits that other types of savings vehicles do not. This guide will provide an overview of money purchase plans, including the different types and some tips on how they work best.
- What is a money purchase retirement plan?
- How is money purchase plans different than other savings vehicles?
- What are some tips when it comes to using money purchase plans?
What is a Retirement Plan?
What Is a Money Purchase Retirement Plan?
A money purchase retirement plan is a form of retirement plan in which an employer must contribute a set amount each year based on the employee’s earnings. Employees may also be required to finance part of their pension. Each year, workers are not permitted to make more than a specific amount of contributions.
They’re similar to a pension since they need employers to contribute money. Learn about how money purchase plans work and who can participate in them.
How Does A Money Purchase Retirement Plan Work?
A money purchase plan is a form of defined contribution retirement account. These plans function similarly to other defined contribution plans like 401(k) and 403(b) accounts, although there are particular distinctions.
The employer must contribute to the money purchase plan every year, regardless of the job’s pay scale.
Money Purchase retirement plans are also known as a money purchase plan, money purchase pension, or money purchase pension plan.
Things To Know
- Depending on the demands of the business, money purchase plans can be made simple or complex. All that is required to establish a plan is for the employer to submit Form 5500, “Annual Return and Report of Employee Benefit Plan,” to the IRS every year.
- A money purchase plan, like other qualified retirement plans, has its own set of IRS regulations.
- If you change jobs, you may roll your money purchase plan into a new IRA, deferred annuity, or 401(k).
- If you withdraw your funds before retiring, you must pay a penalty, typically 10% in addition to ordinary taxes.
- Your employer is not allowed to withdraw money from your account nor let the employee.
- Your employer may allow you to borrow money from the account.
Money Purchase Plan Contribution Limits
The lesser of the following two amounts must be used to calculate your total annual input:
- 25% of employee earnings.
- $57,000 (the same as the limit for other defined contribution plans).
The amounts contributed for high-income employees can’t outweigh the sums dedicated for those who make less; otherwise, the retirement plan will lose its “qualified” status. In addition, the IRS conducts nondiscrimination checks to determine if plans favor certain workers over others.
Pros and Cons of Money Purchase Plans
These plans offer both employers and employees some significant gains but also come with drawbacks.
Pros
- Employees who contribute to a money purchase plan are not taxed on the money until they withdraw it in retirement. The employer is entitled to a tax deduction for payments made to money purchase plans, and contributors are allowed to invest their paychecks tax-free until they take them out of the plan.
- The contribution is deposited into each employee’s account on an annual basis. The amounts put in may increase over time, providing workers with a substantial retirement fund.
- A life annuity, which is generally a monthly benefit over your lifetime, is standard with money purchase plans.
Cons
- The employer’s deduction of a money purchase plan is limited to 25% of the income paid to or earned by qualified plan participants.
- Defined contribution plans generally have higher fees than simpler defined contribution plans.
- If your plan looks to favor those who make more money, you risk losing your qualified plan status and the tax perks that go with it.
- If you don’t meet the minimum funding requirement, you must pay an excise tax.
- The required contribution rate subjects businesses to liability for payments even if earnings are low. This might put a strain on a company’s finances when things aren’t going well.
Alternatives To Money Purchase Plans
A deferred annuity can offer more control to both the employer and the employee. For example, there are no contribution limits, fewer stringent rules from the IRS, receive the same tax-deferred growth, an enhanced lifetime annuity is available, and employers might be able to write off the contributions as a tax deduction (SEP-IRA).
Premium Bonuses
Deferred annuities can offer premium bonuses on contributions that mimic an employer’s 401(k) match with no annual limits.
For example, an annuity may offer a bonus of up to 11% on all contributions for the first seven years of the annuity. The 11 percent premium bonus mimics the employer’s match, and there are no annual contribution limits for the employee.
Unlike a 401(k), employees can open a deferred annuity without an employer.