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A defined contribution plan is an employer-sponsored retirement plan that requires companies to contribute a specific percentage of an employee’s salary each year, regardless of their profitability. Because of this guaranteed membership fee, money purchase plans can be attractive options for employers to attract and retain key employees, although they can be costly for businesses to maintain.
What is a money purchase plan?
Defined contribution plans are defined contribution pension plans sponsored by the employer, such as 401 (k) s and 403 (b) s. As with other workplace pension plans, contributions to defined contribution plans increase on a tax-deferred basis, and employer contributions may be tax deductible for the employer.
Money purchase plans differ from these more well-known plans in several key ways:
• Contributions to a defined contribution plan are made primarily by the employer and not by the employee. Employees can choose how to invest contributions using plan options. Some defined contribution plans also allow employee contributions. When employee contributions are offered, employees may be required to contribute.
• Contributions to a defined contribution plan are set annually. Plan documents show the percentage of an employee’s salary that the employer will contribute to the plan each year. Unlike a profit sharing plan or even some 401 (k) matches, employer contributions do not change based on the profitability of the business throughout the year.
• Money purchase plans often have acquisition schedules. Since the employer bears most or all of the contribution burden, companies want to ensure that an employee doesn’t just take a job to accumulate employer contributions and run. A vesting schedule dictates when certain percentages of a defined contribution plan will be available to an employee. Vesting is not an uncommon feature, even among 401 (k) plans, half of which require some vesting sum for employer contributions.
How much can you contribute to a money purchase plan?
All employer and employee contributions to defined contribution plans are subject to annual limits set by the IRS. These limits are currently the lesser of:
- 25% of the eligible employee’s salary, Where
- $ 57,000
Companies offering any type of defined contribution plan should be careful that their plans do not become too onerous, favoring highly paid employees over employees with lower annual salaries. A plan is considered very heavy if the business owners and highly paid employees own more than 60% of the total assets of the defined contribution plan. If it turns out that a company has a very heavy plan, the plan could lose its “qualifying plan” status, leaving both the employer and participating employees subject to heavy tax penalties.
Money purchase plans are frequently offered in conjunction with profit sharing or 401 (k) plans, but employer contributions are limited to the maximums listed above for all accounts. Employees, on the other hand, can maximize their 401 (k) and also receive the maximum employer contribution on their retirement accounts.
How does a silver buying plan compare to a 401 (k)?
Money purchase plans and 401 (k) plans have some similarities.
“Both require business owners to be extremely efficient in terms of both time and money,” says Brian Halbert, Retirement Specialist at Pensionmark. “Both plans require a lot of administration and record keeping on the part of the employer and the employee. Likewise, both are effective vehicles for employees to save for retirement. “
Other commonalities include:
Despite the many similarities between money buying plans and 401 (k), employers seem to tend to abandon money buying plans in favor of their more well-known (and more flexible) counterparts.
“Right now, many employers are opting for 401 (k) plans because of two main factors: streamlined technology and administration, and lower costs,” says Halbert. “In recent years, the [benefits] the industry has seen a truly incredible drop in the total cost in the 401 (k) plan market.
What Are the Benefits of Silver Buying Plans?
For both employers and employees, defined contribution plans offer several unique advantages that are not found in other types of defined contribution plans.
“The most beneficial aspect of a defined contribution plan is the employer’s ‘forced’ savings,” says Halbert. “By adopting a defined contribution plan, the employer is committed to helping the employee save. When used with other plans like a 401 (k) plan or profit sharing plan, the employee can really save big bucks each year while the employer can increase their talent and culture ranks. .
Money purchase plans can also allow employees to contribute more to their own retirement when used in conjunction with a 401 (k). Although the same employer cannot contribute more than the lesser of 25% of an employee’s salary or $ 57,000, an employee can maximize their 401 (k) contributions. and make more contributions to money purchase plans, says Ben Dobler, CFP, a registered agent with Stewardship Financial Counsel.
What are the disadvantages of silver buying plans?
The biggest downside to money buying plans is for employers. Money purchase plans require employers to contribute a fixed percentage of their employees’ wages each year, regardless of their performance. This, together with comparatively higher administrative costs, can make defined contribution plans more expensive than other defined contribution plans.
For employees, the biggest drawback of a defined contribution plan is the possibility that they may be required to contribute a certain percentage of their salary, depending on their employer’s plan. This could deter potential talent from being uncomfortable with mandatory plan membership.
“For-profit companies that want more flexibility with contributions to employee retirement accounts often choose to offer 401 (k) plans instead, which allow employer contributions but do not require them,” Dobler explains.
The basics of money buying plans
As an employee, you probably won’t choose to work for a company just because or not they offer a money purchase plan. You will likely assess the corporate culture, career opportunities, and the availability of other retirement accounts versus a money purchase plan offer. That said, these plans can be powerful incentives to choose one company over another, everything else being the same, and defined contribution plans can strengthen your retirement savings plan.
As an employer, you might consider offering a money purchase plan if you’re a for-profit business trying to keep top talent in a particular industry. If you can afford the extra administrative costs and minimum contributions, defined contribution plans are definitely worth considering for your benefits portfolio.