What is a Money Purchase Plan?

Published by Thomas Herold in Investments, Laws & Regulations, Retirement

'Money Purchase Plan' is explained in detail and with examples in the Investments edition of the Herold Financial Dictionary, which you can get from Amazon in Ebook or Paperback edition.

Money Purchase Plans are another type of retirement vehicle that some traditional for profit companies offer their employees. In these plans, employees and their employers both make contributions. These contributions from the employers are figured from a yearly earnings percentage.

The plans are different from Profit Sharing Plans in which the annual basis of profitability determines how large the contributions are. Money Purchase Plans’ annual earnings percentages assigned for contributions stay the same ever year as set out in the originals terms of the retirement benefit plan. These plans do not enjoy a great deal of attention from the media. Despite this they are still a critical employer provided retirement vehicle that offers significant tax advantages for employees.

These plans are classified as defined contribution plans much like 401(k)s, even though the employer contributions are mandatory. Employees enjoy account control over the investments as much as the specific plan investment rules permit. Account owners also carry full responsibility for determining when any money is distributed or transferred.

The beauty of these Money Purchase Plans is that every contribution made to them is fully tax deductible while all gains in the account are tax deferred. This means the accounts are funded with pretax dollars. None of the money in the account will become taxable until it is distributed at retirement. The maximum contributions to the accounts in a year from employer and employee are $53,000 for 2016.

There are some downsides to the Money Purchase Plans. A significant one is that the retirement accounts require substantial administration costs for these types of accounts. This comes out of the account returns and earnings on investments. Besides this, account holders are unable to obtain loans from these types of plans. Most other defined contribution plans do allow for such loans to be taken. Rollovers can also be hard to accomplish with these types of plans. The level of difficulty depends on the individual guidelines of a specific plan.

It is critical for anyone considering a rollover to investigate the particular documents of the plan. The IRS does not limit rollovers from these plans. It is instead the specifics of the plans themselves that make it difficult for those who are still working for the company and under the official retirement age to transfer them. When the plan allows for them, rollovers proceed as with any other qualified retirement vehicle. They can be transferred into an individual IRA or rolled into another employer 401(k) plan.

Any individuals who attempt to take cash distributions before they reach the government set retirement age of 59 ½ will suffer substantial penalties. Besides becoming fully taxable, these funds will be subjected to the 10% early withdrawal IRS penalty. Because of the stiff penalties, direct rollovers are more sensible than indirect ones.

When individuals begin indirect rollovers, they receive a check distribution. The 60 day clock to complete the rollover then begins ticking. There are also withholding requirements when these types of indirect rollovers are attempted. Early distribution penalties can result from not completing these rollovers according to the strict IRS timetable.

Investment choices are a weak point of these Money Purchase Plans. Legally they are allowed to invest in individual government and corporate bonds and stocks, mutual funds, options, and exchange traded fund shares. The plan provider may limit these choices further as they see fit.

This means that these accounts may not invest in physical gold bullion holdings directly as with self directed or precious metals IRAs. They can participate in paper gold investments such as gold mining company stocks or mutual funds that own them. They may also purchase gold mining ETFs or gold ETFs like GLD.

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The term 'Money Purchase Plan' is included in the Investments edition of the Herold Financial Dictionary, which you can get from Amazon in Ebook or Paperback edition.