A money purchase plan is an employer-sponsored retirement plan in which the employer must contribute a fixed percentage of each eligible employee’s compensation every year, whether the business had a good year or a bad one. That mandatory, non-discretionary contribution is what sets it apart from more flexible arrangements like profit-sharing plans. The percentage is written into the plan document and can only be changed by formally amending the plan.1Internal Revenue Service. Choosing a Retirement Plan: Money Purchase Plan
How the Fixed Contribution Works
When the employer adopts the plan, it picks a contribution percentage and locks it in. If the plan calls for 5% of each eligible employee’s compensation, the employer deposits 5% for every qualifying worker, every year, regardless of profits or cash flow.1Internal Revenue Service. Choosing a Retirement Plan: Money Purchase Plan The money goes into an individual account for each participant, and the eventual retirement benefit depends entirely on how those investments perform.
Because the benefit isn’t predetermined the way it would be in a traditional pension, money purchase plans fall under the “defined contribution” umbrella alongside 401(k) and profit-sharing plans.2Internal Revenue Service. Retirement Plans Definitions The employer defines the contribution going in, not the payout coming out. Two employees with identical contribution histories can end up with very different balances depending on investment choices and market performance.
Some plans allow employees to make their own contributions on top of the mandatory employer amount, though this requires specific plan language and is less common than in 401(k) arrangements.
Contribution and Compensation Limits
The IRS caps the total that can flow into any one participant’s account each year. For 2026, annual additions — employer contributions, any employee contributions, and forfeitures reallocated from other participants’ unvested balances — cannot exceed the lesser of 100% of the employee’s compensation or $72,000.3Internal Revenue Service. COLA Increases for Dollar Limitations on Benefits and Contributions
There’s also a ceiling on how much of an employee’s pay the plan can use when it runs the contribution formula. For 2026, only the first $360,000 of compensation counts.4Internal Revenue Service. 2026 Amounts Relating to Retirement Plans and IRAs, as Adjusted for Changes in Cost-of-Living An employee earning $500,000 at a company with a 10% money purchase plan would receive a contribution calculated on $360,000, not $500,000.
On the employer’s side, contributions are deductible up to 25% of total eligible compensation paid to all plan participants during the tax year. That’s a generous ceiling for most employers, since few plans set their mandatory rate anywhere near 25%.
The Rigidity Cuts Both Ways
The contribution formula must stay fixed and non-discretionary. An employer who wants to change the percentage has to formally amend the plan document. You can’t quietly contribute less in a bad year and make it up later. Great for employees counting on steady contributions, difficult for businesses with volatile revenue.
The mandatory contribution has to be deposited into the plan’s trust no later than the employer’s tax return filing deadline, including extensions.5Internal Revenue Service. 401(k) Plan Fix-It Guide – You Haven’t Timely Deposited Employee Elective Deferrals – Section: Timing of Other Contributions For a calendar-year C corporation filing Form 1120, that means April 15, or October 15 with the automatic six-month extension. Other entity types have different filing dates, so the contribution deadline shifts accordingly.
Missing the deadline has real consequences. The IRS imposes an excise tax equal to 10% of the unpaid minimum required contribution for single-employer plans.6Office of the Law Revision Counsel. 26 USC 4971 – Taxes on Failure to Meet Minimum Funding Standards If the shortfall still isn’t corrected by the end of a designated correction period, the penalty jumps to 100% of the unpaid amount. Beyond the excise tax, persistent funding failures can lead the IRS to revoke the plan’s tax-qualified status, which unravels the tax benefits for employer and employees alike.
When Employees Actually Own the Money
Vesting determines when employees gain permanent ownership of the employer contributions in their accounts. A money purchase plan must satisfy one of two minimum vesting schedules under ERISA:
- Cliff vesting: 0% ownership until the employee completes three years of service, then 100% all at once.
- Graded vesting: 20% after year two, with another 20% added each year until the employee is fully vested after year six.
Employers can always vest faster than these minimums, and immediate vesting is common in smaller firms trying to attract talent, but they cannot vest slower.7Internal Revenue Service. Retirement Topics – Vesting When an employee leaves before fully vesting, the unvested portion is forfeited. Those forfeitures can be used to reduce future employer contributions or be reallocated to remaining participants, depending on what the plan document provides.8Office of the Law Revision Counsel. 29 U.S. Code 1053 – Minimum Vesting Standards
Getting Money Out
Money purchase plan funds are generally locked up until a triggering event: separation from service, retirement, disability, death, or reaching the plan’s normal retirement age. Unlike 401(k) plans, money purchase plans do not allow hardship withdrawals. This is a common point of confusion. The money is less accessible during employment than many participants expect.
The Age 59½ Penalty
Distributions taken before age 59½ are subject to ordinary income tax plus an additional 10% early withdrawal penalty on the taxable portion.9Internal Revenue Service. Certain Exceptions to the 10 Percent Additional Tax Under Code Section 72(t) A handful of exceptions apply, including distributions due to permanent disability, certain medical expenses exceeding a threshold percentage of income, and qualifying domestic relations orders. Starting in 2026, penalty-free withdrawals of up to $2,600 are also available for long-term care insurance purchases.
Loans
If the plan document allows it, participants can borrow from their accounts. The maximum loan is the lesser of $50,000 or the greater of $10,000 or 50% of the participant’s vested balance.10Internal Revenue Service. Retirement Plans FAQs Regarding Loans Loans must generally be repaid within five years, with substantially level payments at least quarterly. Falling behind turns the outstanding balance into a taxable distribution, which can also trigger the early withdrawal penalty.
Rollovers
When a participant leaves the company or the plan terminates, the balance can be rolled over tax-free into a traditional IRA, another employer’s qualified plan, a 403(b), a governmental 457(b), or a SEP-IRA.11Internal Revenue Service. Rollover Chart Rolling into a Roth IRA is also possible, but the entire transferred amount becomes taxable income in the year of the rollover. Rolling over rather than cashing out avoids both the income tax hit and the early withdrawal penalty.
Required Minimum Distributions
Participants must begin taking required minimum distributions from a money purchase plan in the year they turn 73. Those who are still working and don’t own 5% or more of the sponsoring company can generally delay RMDs until they actually retire.12Internal Revenue Service. Retirement Plan and IRA Required Minimum Distributions FAQs Missing an RMD triggers a steep excise tax on the amount that should have been withdrawn.
Money Purchase Plan vs. Profit-Sharing Plan
The difference comes down to flexibility. A profit-sharing plan lets the employer decide each year whether to contribute, how much to contribute, or whether to skip a year entirely. A money purchase plan locks in the contribution rate. If the plan says 8%, the employer owes 8% of every eligible employee’s compensation, even in a year with zero profits.
Both plan types share the same annual additions ceiling ($72,000 for 2026) and the same compensation cap ($360,000).1Internal Revenue Service. Choosing a Retirement Plan: Money Purchase Plan Both are defined contribution plans, and both offer the same basic tax treatment: employer contributions are deductible, investment growth is tax-deferred, and participants pay income tax only when they take distributions.
Money purchase plans were far more popular before 2001. Profit-sharing plans at the time had a deductible contribution ceiling of just 15% of total eligible compensation, while money purchase plans allowed deductions up to 25%. Employers who wanted to maximize contributions for highly compensated employees would layer a profit-sharing plan on top of a money purchase plan to reach the higher total. The Economic Growth and Tax Relief Reconciliation Act of 2001 eliminated that gap by raising the profit-sharing deduction limit to 25%.13Internal Revenue Service. Chapter 2 Summary of EGTRRA and Recent Law Provisions Overnight, the main reason to accept a money purchase plan’s rigidity disappeared. Most new plans established since then use profit-sharing or 401(k) structures, and many existing money purchase plans were frozen or terminated.
The plan still has a niche. Employers who want to signal a firm commitment to retirement savings, and who can comfortably absorb a fixed annual cost, may prefer the certainty it provides. Employees benefit from knowing exactly what will be contributed each year rather than hoping the employer chooses to fund a discretionary plan.
Ending a Money Purchase Plan
An employer can terminate a money purchase plan, but the process is more involved than simply stopping contributions. The employer must formally amend the plan to establish a termination date and update the document to reflect all current legal requirements as of that date.14Internal Revenue Service. Retirement Plans FAQs Regarding Plan Terminations
On termination, every participant becomes 100% vested immediately, regardless of where they stood on the schedule. An employee who was 40% vested the day before termination becomes fully vested when the plan ends. The employer must distribute all plan assets as soon as administratively feasible, generally within one year. Until those assets are actually distributed, the plan is still considered ongoing and must continue meeting all qualification and reporting requirements. Participants must receive notice of their distribution options 30 to 180 days before the distribution date, and most will want to roll their balances into an IRA or a new employer’s plan to avoid an immediate tax bill.