In a money purchase pension plan, employers are required to contribute a fixed percentage of each eligible employee’s salary annually to each worker’s separate account. The contributions are tax-deductible to the employer and tax-deferred for the employees. Investments grow tax-free until money is withdrawn in retirement.
Contributions for highly paid employees can’t outweigh contributions for lower-paid employees by too much. If complicated “top-heavy” tests show that they do, contribution limits may be reduced for the highly paid.
The Internal Revenue Service also can punish the company with excise taxes if it fails to fully fund its plan.
Money purchase plans were once commonly combined with profit-sharing plans, which gave companies the benefit of high contribution limits and a degree of flexibility in determining the amount of each year’s contributions. In recent years, though, contribution limits have risen significantly for much simpler types of plans, removing most of the advantage from the money plan/profit-sharing combination.