Money Purchase Pension Plan

A money purchase pension plan is a defined contribution plan under which the employer's contribution is set by a formula written into the plan document and is not tied to profits or to employer discretion. IRS Publication 560 puts it directly: "If contributions are fixed and are not based on the employer's profits, the plan is a money purchase pension plan (a defined contribution plan)."

On the naming: the IRS uses both the fuller "money purchase pension plan" and the shorter "money purchase plan," and they mean the same thing. The longer form is the more useful one, because the word "pension" is not decoration; it places the plan inside a body of rules built for defined benefit plans, which is where every practical surprise in this design comes from. What the plan is called is also not a matter of inference: IRC §401(a)(27)(B) requires the plan document to designate its type, so whether an arrangement is a money purchase pension plan or a profit-sharing plan is an election recorded in writing, never something deduced from how the employer has behaved.

Why "mandatory" is a legal conclusion, not a style choice. The requirement traces to the definitely-determinable-benefits rule in Treasury Regulation §1.401-1(b)(1)(i): benefits must be determined by a stipulated formula that is not subject to the discretion of the employer. Once the document says the employer contributes, say, 10% of each eligible participant's compensation, that is a promise for every year, not a target.

The three consequences of being a pension plan. These are what a reader arriving from the defined contribution world will not expect, and they are the sharpest contrast with a profit-sharing plan:

First, minimum funding standards apply under IRC §412: for a money purchase plan, the minimum required contribution is simply the amount the plan document says. A missed or underpaid contribution becomes an unpaid minimum required contribution rather than a skipped year, and it exposes the employer to a 10% excise tax on the shortfall under §4971(a), reported on Form 5330 — escalating to a further 100% tax under §4971(b) if it is not corrected. Second, the plan must offer a qualified joint and survivor annuity to married participants: the survivor annuity requirements of IRC §§401(a)(11), and 417 reach all defined benefit plans and all other plans subject to the §412 funding standards, which is to say money purchase pension plans, including target benefit plans. Waiving that form requires the spouse's written consent, witnessed by a plan representative or a notary. Third, in-service distributions are barred before the retirement age the plan specifies or the age permitted by IRC §401(a)(36), where a profit-sharing plan may allow withdrawals on far more flexible terms.

What "pension" does not buy. There is no Pension Benefit Guaranty Corporation coverage. This is still a defined contribution plan: the participant has an individual account, chooses or receives investments, and bears the investment outcome. The employer's promise is to contribute the stated amount, not to deliver a stated retirement benefit. Nobody should read the word "pension" here as a guarantee. The contrast with a cash balance plan is instructive: that design also looks like it has account balances, but it is legally a defined benefit plan, so the employer carries the investment risk and the benefit is usually PBGC-insured. Same appearance, opposite allocation of risk.

Why the design faded. Before 2002, the employer deduction limit for a profit-sharing plan was 15% of compensation while a money purchase pension plan allowed 25%. Employers who wanted the full 25% therefore ran paired plans — a money purchase pension plan for the mandatory core plus a profit-sharing plan for the flexible remainder — accepting a funding obligation purely to reach a higher deduction. The Economic Growth and Tax Relief Reconciliation Act of 2001 raised the profit-sharing limit to 25% for plan years beginning after 2001-12-31, which removed the only reason to accept the obligation, and paired plans were merged or terminated in large numbers. The design remains legal and in use, and one niche is genuinely live: prevailing-wage plans under Davis-Bacon and similar rules, where a contractor discharges the fringe-benefit component of a prevailing wage as a retirement plan contribution instead of cash, and a mandatory formula is precisely what is wanted.

A target benefit plan is a close cousin: a money purchase variant whose formula is age-weighted and works backwards from a targeted retirement benefit, so it looks like a defined benefit design while running on defined contribution mechanics and carrying the same pension-plan consequences. The general defined contribution mechanics (individual accounts, investment risk, portability) belong to defined contribution plan.

The plan document states a contribution formula; the employer funds it each year for every eligible participant; each participant's account is invested and paid out under the plan's distribution rules, which for a pension plan are tighter than a profit-sharing plan's.

A hypothetical example. A plan document requires the employer to contribute 10% of each eligible participant's compensation. Five employees have total eligible pay of $420,000, so the required contribution is 10% × $420,000 = $42,000, in a strong year and in a weak one alike. An otherwise identical profit-sharing plan could have declared $0 that year with no consequence.

Now the failure case, which is where the pension label bites. Suppose the employer funds nothing. The full $42,000 is an unpaid minimum required contribution, exposing the employer to a 10% excise tax on it (10% × $42,000 = $4,200) reported on Form 5330, with a further 100% tax on the amount still unpaid if the shortfall is not corrected. And the obligation itself does not disappear: the money is still owed to the plan. Figures are illustrative.

Pros

• Employees receive a contribution they can genuinely count on, which a discretionary plan cannot promise.
• The formula is simple to communicate and requires no annual decision or testing calculation.
• Fits situations where a mandatory contribution is the actual goal, notably prevailing-wage work where the contribution substitutes for cash wages.
• Being a defined contribution plan, it keeps individual accounts and normal rollover portability.

Cons

• The contribution is required every year regardless of business conditions, and a shortfall is a funding deficiency with excise tax exposure.
• The qualified joint and survivor annuity requirement adds spousal consent paperwork to distributions.
• In-service withdrawals are restricted more tightly than in a profit-sharing plan.
• No Pension Benefit Guaranty Corporation insurance, despite the word "pension", the participant still carries investment risk.
• Since 2002 a profit-sharing plan can generally reach the same deduction limit without the obligation, so most employers have no reason to choose this design.