What it means
Most workplace retirement plans leave the employer room to decide each year what to put in. A money purchase plan removes that discretion: the plan document fixes the contribution rate, and the employer must pay it annually, profit or no profit.
The United States Internal Revenue Service treats it as a defined contribution plan with a compulsory employer formula. Individual accounts grow with the contributions plus investment returns, and the eventual pension depends on what the pot buys at retirement.
The fixed commitment cuts both ways. Employees gain certainty that the money arrives every year, while the employer carries an obligation that does not shrink in a bad year, which is why the design suits stable firms more than volatile ones.
The plan differs from its cousin, the profit-sharing plan, precisely on this point. A profit-sharing contribution flexes with the employer's results and choices; a money purchase contribution is a contractual percentage, commonly reaching a quarter of pay in older designs, that cannot be skipped without breaching the plan.
Contribution limits still apply. Annual additions to each account are capped by tax rules, and contributions above the fixed percentage are not permitted, so the plan is rigid in both directions.
For a business owner, the money purchase plan is a promise worth making deliberately. It is a powerful recruitment and retention tool for long-tenured staff, but signing the plan document means the contribution becomes a fixed cost of employment, and owners should model the lean years before committing.
The design has faded in some markets but survives in others. Where it persists, it often sits alongside newer flexible plans, giving long-serving staff the old certainty while newer hires join more discretionary arrangements.
In practice
Real-world examples.
Example
A small law firm adopts a money purchase plan committing 10 percent of salary yearly. Young associates cite the guaranteed contribution as a reason to stay, and the firm budgets it alongside rent as an unavoidable cost.
Example
A seasonal business with a money purchase plan faces a lean year. Unlike its neighbour's profit-sharing plan, the contribution cannot be reduced, and the owner draws on reserves to fund it as the plan document demands.
Example
An employee compares two job offers. One includes a 5 percent money purchase contribution; the other a discretionary bonus of similar size. She takes the first, because the contribution is a contractual obligation rather than a hope.
Formula
Calculation
Annual contribution = fixed percentage x eligible salary. The employer's total yearly cost is that figure added up across every eligible employee, and it is due whether or not the business made a profit.
Worked example. A firm commits to 10% of pay for an employee earning $80,000, so the contribution is 10% x $80,000 = $8,000 a year. With 20 such employees the firm owes 20 x $8,000 = $160,000 a year. For the employee, assume the $8,000 is paid at the end of each year and earns 5% annually: the account after 25 years is $8,000 x ((1.05^25 - 1) / 0.05), which is $8,000 x 47.73, roughly $381,800, before salary growth, fees and tax. Contributions supply 25 x $8,000 = $200,000 of that total, and investment growth supplies the remaining $181,800 or so.Case study
Seen in the real world.
In this illustrative fictional case, Priya runs an engineering consultancy of forty staff and wants to bind senior engineers to the firm. Her adviser lays out two routes: a flexible profit-sharing plan or a money purchase plan with a fixed 8 percent commitment. Priya models three bad years back to back, confirms the fixed contribution survives her stress test, and adopts the money purchase design. Five years on, attrition among senior engineers is half the industry rate, and the plan's predictability lets staff plan their retirements with unusual confidence. Priya's advice to peers is that the guarantee is exactly the point: staff can price a promise, and they cannot price a discretion.
Watch out
Common mistakes.
- Confusing a money purchase plan with a profit-sharing plan, when the first obliges a fixed annual contribution and the second lets the employer vary or skip it.
- Adopting the fixed commitment without stress-testing lean years, when the contribution is due regardless of profits and breaching the plan carries real consequences.
- Assuming the fixed rate guarantees a fixed retirement income, when the pension still depends on investment returns, and only the contribution is certain.
Questions
People also ask.
Who contributes to a money purchase plan?
Primarily the employer, at a fixed percentage of salary set in the plan document. Some designs allow or require employee contributions on top, all within annual tax limits.
How does it differ from a 401(k)?
A 401(k) centres on employee deferrals with optional employer matching. A money purchase plan centres on a mandatory employer contribution that cannot be skipped, regardless of the company's year.
What happens to the money at retirement?
The accumulated account is used to provide retirement income, historically often an annuity. The eventual pension depends on contributions plus investment growth, not on a promised formula.
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