A crucial aspect of retirement planning is understanding the various contribution limits associated with different financial products. Among these, Money Purchase and Profit Sharing Plans play a significant role in many employees' retirement strategies. These types of plans can provide valuable tax benefits, and the contributions made by employers form an integral part of the retirement corpus. However, these benefits are subject to certain limits, which need to be understood to optimize retirement savings.

Contribution Limits: The Basics

Money Purchase Plans and Profit Sharing Plans are primarily employer-funded. Contributions to these plans are generally capped at 25% of the employee's gross compensation. It's essential to remember that the contributions come exclusively from the employer, with no employee contribution expected or required.

For self-employed individuals or partners in pass-through entities, the net contribution percentage is effectively limited to 20% of net profits. This limit is in place because self-employment taxes reduce the amount of profit considered compensation, and the actual contribution further reduces it. The intricacies of self-employment contributions may require consulting a financial advisor to maximize the potential benefits.

The 'Integration' Provision: A Benefit for High Earners

An interesting provision in both Money Purchase and Profit Sharing Plans allows a slight increase in contributions to integrate with Social Security benefits. However, this provision primarily benefits high earners whose income surpasses the cap on the maximum considered compensation. In 2016, this cap was set at $265,000.

The additional contribution under this provision is capped at 6% of the total compensation paid to all employees for the year. The rationale behind this addition is that high earners will receive a significantly smaller percentage of their previous salary from Social Security, thus balancing their retirement savings. For a deeper understanding of Social Security eligibility, it's advisable to research the topic further or consult a professional.

Integration with Other Retirement Plans

Money Purchase and Profit Sharing Plans can be integrated with other retirement plans. However, caution is necessary to ensure that the total contributions from either employees or employers do not breach the allowable limits. Also, Money Purchase Plans cannot be combined with 401(k) deferral plans, a rule established under the Employee Retirement Income Security Act (ERISA) in 1974.

Tax Considerations

Contributions to Money Purchase and Profit Sharing Plans are currently tax-deductible for employers, offering a significant incentive for businesses to contribute towards their employees' retirement. On the other hand, benefits received by employees from these plans are taxable upon distribution, a factor that needs to be accounted for in retirement planning.

Understanding the contribution limits for Money Purchases and Profit Sharing Plans is a vital part of retirement planning. By staying informed about the percentage limits, the integration provision, and potential tax implications, individuals can make the most out of these valuable retirement savings tools.

Summary:
Contributions are generally limited to 25% of employee compensation, but a small addition amount may be contributed for higher-income employees. Money Purchase plans and Profit Sharing plans are funded by employer contributions, and in general these contributions cannot exceed 25% of gross compensation.

For a self-employed person or a partner in a pass-through entity, the real percentage of contributions cannot exceed 20% of net profits because self-employment taxes will reduce the amount of profits considered compensation, as will the actual contribution.

There is a provision in both of these plans that allows the contributions to be increased slightly to “integrate” with Social Security, but this only applies to higher earners whose income exceeds the cap on “maximum considered compensation,” which is $265,000 in 2016.

This additional contribution cannot exceed 6% of the total compensation paid to all employees for the year. The idea behind this additional amount is that higher earners will be paid a much smaller percentage of their former salary by Social Security.

To learn more information about Social Security eligibility, see “Am I Eligible for Social Security Benefits?”

It is important to note that all contributions are made only by the employer in these plans, but they can be integrated with other retirement plans as long as the total contributions from either employees or employer do not exceed the allowable limits.

Be careful about integrating Money Purchase plans with other plans, however, since they cannot be combined with 401(k) deferral plans since ERISA in 1974. Contributions are currently deductible to employers and benefits are taxable to employees upon distribution.

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