Understanding the Money Purchase Plan
A Money Purchase Plan (MPP) is a type of defined contribution retirement plan primarily sponsored by employers. Under this plan, the employer commits to making annual contributions calculated as a fixed percentage of each eligible employee’s salary. Unlike defined benefit pension plans—which guarantee a specific retirement benefit amount—money purchase plans focus on fixed employer contributions over time. The employee’s eventual retirement income depends on the contributions made plus investment earnings.
Historical Context
The Money Purchase Plan has its regulatory foundation in the Employee Retirement Income Security Act (ERISA) of 1974. ERISA established uniform standards to protect employee retirement assets, including funding rules and disclosure requirements for retirement plans. The MPP became an attractive alternative for employers seeking a simpler way to offer retirement benefits without the complex liabilities associated with traditional pension plans.
How the Money Purchase Plan Works
Employers calculate contributions as a specified percentage of payroll annually—commonly between 5% and 10%. For example, if an employee earns $60,000 and the contribution percentage is 7%, the employer deposits $4,200 into that employee’s retirement account for the year. This contribution occurs regardless of the company’s profitability, ensuring stable funding to the employee’s retirement savings.
Employee contributions are generally limited or not permitted, depending on the plan’s design. The employer’s contributions are invested in various assets such as stocks, bonds, or mutual funds, with the investment risk borne by the employee. The final retirement balance depends on the accumulated contributions and how well those investments perform over time.
Eligibility and Usage
Money Purchase Plans are often used by small to mid-size employers who prefer straightforward retirement plan administration. While less common than 401(k) plans, they remain relevant for employers seeking predictable retirement contributions and employees desiring consistent employer-funded savings.
Key Features and Benefits
- Mandatory Employer Contributions: Employers must contribute a fixed percentage of salaries annually, regardless of financial results.
- Investment Growth Potential: Contributions are invested to potentially grow the retirement nest egg.
- Predictable Savings: Employees can expect steady funding accumulation.
- Limited Employee Contributions: Typically, employees do not make contributions, simplifying plan management.
Common Misunderstandings
- Difference from 401(k) Plans: Unlike 401(k)s, where employees decide their contribution amounts, Money Purchase Plans have fixed employer contributions and limited employee input.
- Obligation to Fund: Employers can face penalties if they fail to meet contribution requirements due to the plan’s legal funding commitments.
- Not a Guaranteed Benefit: Retirement income depends on investment performance; there is no guaranteed payout like in defined benefit plans.
Tips for Participants
- Review the vesting schedule to understand when employer contributions become fully owned.
- Explore investment options within the plan to optimize growth.
- Understand whether the plan allows voluntary employee contributions to increase savings.
- Monitor your employer’s commitment to ensure consistent contributions.
Money Purchase Plan vs. 401(k) Plan
| Feature | Money Purchase Plan | 401(k) Plan |
|---|---|---|
| Employer Contributions | Fixed percentage of salary, mandatory | Optional; may include employer matching |
| Employee Contributions | Limited or not allowed | Yes, employee chooses contribution amount |
| Contribution Flexibility | No | Yes |
| Investment Risk | Employee | Employee |
| Plan Popularity | Less common; preferred by some small and mid-size employers | Most common employer retirement plan |
Practical Example
Imagine your employer offers a Money Purchase Plan with an 8% contribution rate. If you earn $50,000 annually, your employer will deposit $4,000 into your retirement fund yearly. Over 20 years, with average investment returns, this can compound into a substantial retirement balance.
Further Guidance and Resources
For more information on defined contribution plans, visit our Defined Contribution Plan glossary.
Learn about employer-mandated contributions and retirement plan requirements at the IRS Retirement Plans FAQs.
Conclusion
Money Purchase Plans offer a structured, employer-funded solution for retirement savings with predictable yearly contributions. While overshadowed in popularity by 401(k) plans, MPPs provide an important retirement option for certain employers and employees seeking consistent funding commitment without the liabilities of traditional pensions.
References
- Employee Retirement Income Security Act (ERISA), U.S. Department of Labor: https://www.dol.gov/agencies/ebsa/about-ebsa/our-activities/resource-center/faqs/erisa-general
- IRS Retirement Plans FAQs: https://www.irs.gov/retirement-plans/retirement-plans-faqs-regarding-required-minimum-distributions
- Investopedia, Money Purchase Plan: https://www.investopedia.com/terms/m/moneypurchaseplan.asp
(Reading level: approximately 9th grade)