Money Purchase plans and Profit Sharing plans are two types of Defined Contribution plans that can be used at a business, together if desired. Both of these are Defined Contribution plans, which means that only the terms of the contributions to the plan are defined in the plan document.
This is different than Defined Benefit plans, which specifically define the benefit due to an employee at retirement, which is generally a monthly pension payment. If an employer wants to use both a Money Purchase plan and a Profit Sharing plan, it is possible, but since both of them are Defined Contribution plans, they will be limited in aggregate to the allowable defined contribution limits for employer contributions.
To learn more information about the differences, see”What’s the Difference between a Defined Benefit Plan and a Defined Contribution Plan?”
In 2016, this is defined as 25% of compensation up to $53,000 per employee. Money Purchase Plans are called pension plans as well, but they do not define the income benefit due at retirement. In these plans, employers are obligated to pay a set percentage of each employee’s compensation, but the assets are in a separate account for each employee, and each employee bears the investment risk.
So the term “pension” is used very loosely here, because there is no sure payment of income at retirement, unless the participants are funding annuity contracts with guarantees. Profit Sharing Plans only have to pay into participant accounts when a profit is declared. In a money-purchase plan, on the other hand, contributions must be made even in years without a profit.
Profit sharing plans give employers more flexibility in determining how much of the profits will be contributed to the account. They will still need to adhere to whatever standards they have set forth in their plan document. Contributions to both plans are not taxable until they are withdrawn in retirement.
Money purchase and Profit-Sharing plans can not only be combined together, but can also be combined in 401(k)s and other plans that may have more room for employee contributions and employer matching. Up to 6% of employee compensation can be contributed in the form of a match without decreasing the amount of contributions an employer can make through profit-sharing and money-purchase arrangements.
Where do I Get Started in Saving for Retirement?
How Does a 401(k) Compare With Other Retirement Plans?
What role does inflation play in my retirement planning?
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