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davidlerner.com > Women and Finances  > Money Purchase Plans: Another Way to Share Company Profits

Money Purchase Plans: Another Way to Share Company Profits

There are two main types of plans available that enable businesses to share profits with their employees: a traditional profit-sharing planand a money purchase plan. These plans are very similar to each other, with two key differences:

First, employers are required to contribute money each year to a money purchase plan. Conversely, contributions to profit-sharing plans are discretionary: If profits are down, the business can skip contributions for a particular year, or contribute less than it did the year before.

Second, both employers and employees can make contributions to a money purchase plan. Only employers are allowed to make contributions to profit-sharing plans. Money purchase plans are sometimes used in conjunction with profit-sharing plans.

Any size business (including self-employed individuals) can establish a money purchase plan, and the business can offer other types of retirement plans in addition to the money purchase plan if it chooses. Businesses that offer money purchase plans must file IRS Form 5500 each year, just like they do with a profit-sharing plan.

Fixed Contribution Percentages

Employers are required to contribute a fixed percentage of each eligible employee’s annual compensation to his or her money purchase account every year. These contributions are tax-deductible for the company as a business expense. In 2012, up to 25 percent each employee’s compensation or $50,000, whichever is less, can be contributed to his or her profit-sharing account.

All employees must be included in a money purchase plan, with two exceptions: Employees who are under age 21 and those who have not yet completed one full year of service with the company (having worked at least 1,000 hours during the year). Businesses can exclude these employees from the plan should they choose.

All contributions (both employer and employee) to a money purchase plan are tax-deferred, which means they generally are not subject to federal or state income taxes until employees start making distributions. The money can be invested however employees choose: in stocks, mutual funds and other investment vehicles, for example, depending on their retirement goals and risk tolerance.

Like a profit-sharing plan, penalties may be assessed if employees withdraw funds from their money purchase plan before retirement. A 10 percent penalty is usually assessed on withdrawals made before age 59½, on top of income taxes that must be paid at ordinary income tax rates.

Vesting Schedules and Plan Loans

Employers can establish a vesting schedule for a money purchase plan so that contributions become vested over time, and they can also allow participants to borrow money from their accounts if they choose. Also like profit-sharing plans, money purchase plans must be designed to benefit both rank-and-file employees and owners and executives. Annual “top heavy” testing is required to ensure that the plan doesn’t discriminate in favor of highly compensated employees.

To learn more about money purchase plans, including whether a money purchase plan or a profit-sharing plan might be the best fit for you and your employees, please contact David Lerner Associates at (877) 367-5960.

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