Online QDRO Preparation. Start Today >
A Money Purchase Plan is a defined contribution plan and is referred to as a 401(a). Employers (and in some cases, employees) make contributions based on a percentage of the employee’s annual earnings, in accordance with the terms of the plan. The employer must contribute a fixed percentage of each employee’s salary every year. The contributions must be made regardless of the company’s performance. Depending on the contributions and investment return earned on them, the amount in each Money Purchase Plan member’s account differs from one member to the next.
The law permits, but does not require, employees to contribute to the plan if it is so configured by the employer and approved by the IRS. Interest and income earned on the contributions are reinvested tax deferred. The employer’s contributions are tax-deductible to the employer and tax-deferred for the employees. Therefore, employer contributions are not included in gross income on the employee’s IRS Form W-2. Investments grow tax-free until money is withdrawn in retirement.
If the employer permits employee contributions, these contributions to the plan are made in a pre-tax manner or after-tax manner. If the employer has a “pick up” provision the contributions are made pre-tax. If the employer does not have a “pick up” provision the contributions are made after-tax. The employer usually makes the choice between these two options. Employers who have established money-purchase plans for their employees are required to file Form 5500 annually with the IRS.
Upon retirement, the pool of capital in the member’s account can be used to purchase a lifetime annuity. In that way, the risk of ensuring an adequate level of retirement income falls on the employee.
The employee is only eligible to take a distribution from their Money Purchase Plan if a "triggering event" occurs, such as reaching age 59½, severance from employment, death, disability, financial hardship, or plan termination. In these situations, employees may take distributions; however, they will have to pay taxes on the money in the year they withdraw it. In addition, the IRS may impose a 10% penalty tax on any distributions taken before the employee reaches age 59½. When money is distributed from the plan, 20% of the distribution will generally be withheld as a prepayment of income taxes. Participants must begin taking distributions no later than April 1st following the last year of employment or age 70½, whichever is later.
Unless the participant chooses otherwise, the benefit payment includes a survivor’s benefit. This survivor’s benefit, called a qualified joint and survivor annuity (QJSA), provides payments over the retiree’s lifetime and his or her spouse’s lifetime. The survivor’s benefit payment can vary but is often half of the benefit payment the participant received while alive.
There are a number of benefits to enrolling in a Money Purchase Plan. 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 a Money 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 tax implications. 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.
Like other pension plans, a Money Purchase Plan is subject to division and distribution in a divorce. In the divorce, the account balance is normally divided between the divorcing spouses.