Traditional Money Purchase Pension Plan
The Basics: The employer contributes a defined or fixed percentage of the participating employee's compensation each year. Whatever that fund grows to is what the retiring employee receives.
How It Works
A. Employer contributes a fixed percentage of the panicipant's compensation each year to the plan.
B. The total employer contribution is then allocated on that basis or on a separately defined basis.
C. Employer contributions are tax deductible. IRC Sec. 404(a)
D. Contributions are not taxed currently to the employee. IRC Sec. 402(a) and 403(a)
E. Earnings accumulate income tax-deferred. IRC Sec. 501(a)
F. Distributions can be tax-favored (eligible for 5-year forward averaging or rolled over into an IRA) retirement. TRC Sec. 402 and 403
Additional Considerations
A. Maximum Annual Contribution: Up to 25% of covered payroll can be contributed and deducted by the employer.
B. Contribution Base: Plan contributions are normally based on total compensation; e.g., base salary, bonuses, overtime, etc. The maximum compensation recognized in 1999 is $160,000.
C. Individual Limits: The allocation of contributions to a participant's account may not exceed the lesser of 25% of compensation or $30,000 per year.
D. Excluding Persons: Certain persons can be eliminated on the basis of months of service, age or coverage in a union plan; for example, persons under age 21 can be excluded from the plan.
E. Investment of Plan Assets: Investments must be diversified and prudent. Subject to plan provisions, plan assets may be invested in equity products like mutual funds, stocks and debt free real estate; or debt instruments like T-Bills and COs. Insurance products like life insurance and annuity policies may also be used.
F. Social Security Integration: Since the employer already contributes to the employee's Social Security retirement benefit, these contributions can be integrated into the contribution and/or allocation formulas of the plan
G. Parties which are favored: Typically younger participants are favored because they have a longer time for their fund to grow and, in some instances, share in forfeitures.
H. Forfeitures: As participants leave the company and separate from the plan, those
less than 100% vested forfeit that part of the account in which they are not vested. The
non-vested forfeitures may then be allocated to the remaining participants or used to
reduce future employer contributions. Those participants who remain in the plan the
longest will share in the most forfeiture.
How Much Will There Be At Retirement?
This will depend upon three factors:
A. The amount of contributions
B. The number of years until retirement
C. The investment return
The risk of poor investment returns rests upon the employee, however, if the investment results are favorable, the participant will have a larger fund at retirement age.
Future Contributions
An employer must make annual contributions to the plan; but to the extent that the future payroll can be forecast, so can the approximate amount of future contributions. Changes may be made prospectively in the level of employer contributions.
Top-heavy Plans
If more than 60% of the plan assets are allocated to key employees the employer must contribute at least as much for non-key participants as it does for key employees. This requirement applies only to a contribution of up to the first 3% of includable compensation higher in some instances).
Advantages To Employer
A. Contributions are tax deductible.
B. Contributions and costs are known in advance.
C. Contributions will rise as compensation rises; but they are controllable both by formula and absolute dollar amounts.
D. Forfeitures of terminating employees may reduce future costs or be reallocated among the accounts of those still in the plan.
E. The plan is easier to understand by the employees than is a defined benefit plan.
F. It can provide employees with permanent life insurance benefits that need not expire nor require costly conversion at retirement age.
G. The employer can direct investments.
Advantage To Employees
A. Annual employer contributions are not taxed to the participant.
B. Earnings on the account are not currently taxed.
C. Distributions at retirement may be tax-favored.
D. Participants can be given the right to direct investments.
E. Participants can also have a traditional, deductible WA7 or a Roth IRA, subject to certain income level limitations based on filing status.
F. There is the ability to purchase significant permanent life insurance, which is not contingent upon the company group insurance program. Purchase of life insurance will generate taxable income to the employee (PS 58).
G. Younger employees can accumulate a larger fund than with a defined benefit plan.
H. Employee can borrow from the plan within certain legal guidelines if provided for in the plan documents.
I. The forfeited, unvested portion of accounts of former participants may be reallocated to the active participants' accounts. This can have a substantial impact on fixture benefits.
Disadvantages To Employer
A. In low profit years, the employer is still obligated to make contributions.
B. While contribution levels may be changed from time to time this should not be done annually.
C. The money purchase plan will generally not produce as large of a contribution and deduction for older employees (i.e.age 50 or more) as will a defined benefit plan.
Disadvantages To Employees
A. There is no guarantee as to future benefits.
B. Investment risks rest on the participant.
C. Older participants may not receive as great of a benefit as with a defined benefit plan.