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A money purchase plan is a type of qualified defined contribution retirement plan in which the employer is required to contribute a fixed percentage of each eligible employee's compensation every year, regardless of whether the company is profitable. The employer's contribution obligation is set in the plan document, typically between 3% and 25% of compensation, and cannot be skipped even in difficult financial years. Employees may or may not make additional contributions, depending on the plan's design. Benefits at retirement depend on how much was contributed and how the invested funds performed over time.
Think of a money purchase plan as a defined contribution plan with a mandatory employer deposit: the employer cannot skip a year because business was slow.
Both money purchase plans and profit-sharing plans are defined contribution arrangements where employees accumulate account balances invested in the market. The key difference is contribution flexibility.
In a profit-sharing plan, the employer chooses how much to contribute each year, ranging from zero to 25% of eligible compensation. In a strong year, the employer might contribute 15%. In a weak year, the employer might contribute nothing. A money purchase plan requires a fixed percentage every year with no discretion. This mandatory nature makes money purchase plans less flexible for employers but more reliable for employees who can plan their retirement savings around a predictable employer contribution.
Money purchase plan contributions are subject to the Section 415 annual additions limit, which for 2025 is the lesser of $70,000 or 100% of the employee's compensation. Employer contributions count toward this limit. Employee contributions, if the plan permits them, also count. An employee earning $50,000 with a 15% employer contribution receives $7,500 in employer contributions, well within the $70,000 cap. An employee earning $300,000 with a 25% employer contribution formula hits the cap at $70,000 rather than $75,000.
Employer contributions to a money purchase plan are deductible as a business expense in the year contributed, subject to the 25% of total eligible compensation deduction limit for the plan. Employees do not pay income tax on employer contributions when made. Investment earnings grow tax-deferred until withdrawn. Distributions in retirement are taxed as ordinary income. Early withdrawals before age 59½ trigger both ordinary income tax and a 10% penalty, with the same limited exceptions that apply to other qualified plans.
Employer contributions to money purchase plans are subject to vesting schedules that determine when employees own those contributions fully. Plans can use cliff vesting, where employees vest 100% after a defined number of years up to three years, or graduated vesting, where ownership increases incrementally over a period up to six years. Under the SECURE 2.0 Act signed in December 2022, long-term part-time employees who work at least 500 hours per year for two consecutive years must be allowed to participate in 401(k) and most other qualified plans, including money purchase plans.
Money purchase plans were more common before 2002, when profit-sharing plans were limited to a 15% deduction. After Congress raised the profit-sharing deduction limit to 25% in 2001, most employers who wanted to contribute up to 25% could do so through a more flexible profit-sharing arrangement without the mandatory annual contribution burden of a money purchase plan. New money purchase plan adoptions have declined significantly since then, though existing plans remain in operation.
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