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What is a Money Purchase Plan?

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  • Written By: Diane Goettel
  • Edited By: W. Everett
  • Last Modified Date: 28 August 2016
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A money purchase plan is a plan in which an employer makes contributions to an employee's savings plan. The amount of money that the employer contributes is usually based on the employee's own contribution. The amount of money that an employer contributes to a money purchase plan may also be gauged in proportion to the employee's salary.

It is quite common for these plans to work on a matching basis. This means that the employer will contribute the same amount to the plan that the employee does. In other cases the amount that an employer contributes will be an agreed upon set amount or a specific percentage of either the employee's salary or the employee's contribution.

These plans are usually established to help save for an employee's retirement or pension. Once a plan has been established, it is mandatory for the employer to contribute to the plan every year, as per the employment agreement unless that employment agreement includes stipulations otherwise. Although there are some similarities between a money purchase plan and a profit sharing plan, the main difference is that, unless there is a stipulation otherwise, the employer must contribute to the plan whether the company experiences profits or losses. In a profit sharing plan, on the other hand, the amount of money that an employee receives is based on the company's performance and profits.

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In the United States tax system, a money purchase plan is referred to as a 401(a). The contributions to this plan may be made in a pre-tax manner or in an after-tax manner. The choice between these two options is usually made by the employer.

There are a number of benefits to enrolling in a money purchase plan or 401(a). One of the most obvious benefits is saving for retirement and establishing financial security. Another benefit, which is more immediate in terms of one's financial life, is that contributing to the purchase plan can help to reduce one's income taxes.

Before enrolling in a money purchase plan, it is important to be sure to understand all of the requirements related to contributions and the ways in which the plan will affect one's taxes. It is also important to understand the rules about how and when the money can be withdrawn from the plan as well as how this relates to taxation. All of this information is usually offered by the employer, but can be reviewed with an accountant.

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