What Is a Money Purchase Plan and How Does It Work?

A money purchase plan is an employer-sponsored retirement plan in which the employer commits, in writing, to contribute a fixed percentage of each eligible employee’s pay every year, no matter how the business performs that year. The contribution rate is set in the plan document when the plan is adopted, and changing it later requires a formal amendment. For 2026, total annual additions to any one participant’s account cannot exceed the lesser of 100% of compensation or $72,000.¹

How the Fixed Contribution Works

When an employer adopts the plan, it picks a percentage and writes it into the plan document. 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.² The money goes into individual accounts, and the eventual retirement benefit depends entirely on how those investments perform.

Because the benefit isn’t predetermined the way a traditional pension’s is, money purchase plans are classified as defined contribution plans, alongside 401(k)s and profit-sharing plans.³ The employer defines what goes in; the market decides what comes out. Two employees with identical contribution histories can end up with very different balances.

Some plans permit employees to add their own contributions on top of the mandatory employer amount. That’s less common than in 401(k) plans and requires specific plan language. Any employee contributions count toward the annual additions limit but sit separately from the employer’s fixed obligation.

Contribution Limits and Deduction Ceiling

The IRS caps the total that can flow into a participant’s account in any year. For 2026, annual additions — employer contributions, any employee contributions, and forfeitures reallocated from other participants — cannot exceed the lesser of 100% of the employee’s compensation or $72,000.¹ That dollar figure adjusts for inflation.⁴

There’s also a ceiling on how much of an employee’s pay the plan can plug into its formula. For 2026, only the first $360,000 of compensation counts.⁵ An employee earning $500,000 at a company with a 10% money purchase plan gets a contribution based on $360,000, not $500,000.

On the employer side, contributions are deductible up to 25% of total eligible compensation paid to all plan participants during the tax year. Few plans set their mandatory rate anywhere near that ceiling.

The Top-Heavy Rule

If more than 60% of plan assets belong to key employees — owners, officers, and high earners — the plan is top-heavy. When that happens, the employer must contribute at least 3% of compensation for every non-key employee, even if the plan’s normal formula calls for a lower rate. If the highest contribution rate for any key employee is below 3%, non-key employees receive that lower rate instead.⁶ Small businesses with a few highly compensated owners can easily fall on the wrong side of that 60% threshold and end up owing more than the base formula would suggest.

The Funding Obligation and Missed Deadlines

The mandatory contribution must reach the plan trust no later than the employer’s tax return filing deadline, including extensions.⁷ For a calendar-year C corporation filing Form 1120, that’s April 15, with the automatic six-month extension carrying the outside deadline to October 15. Other entity types follow their own filing dates.

Missing that deadline has teeth. The IRS imposes an excise tax equal to 10% of the unpaid minimum required contribution for single-employer plans.⁸ If the shortfall isn’t corrected by the end of a designated correction period, the penalty jumps to 100% of the unpaid amount. Persistent funding failures can lead the IRS to revoke the plan’s tax-qualified status, which unwinds the tax benefits for the employer and every participant.

The contribution formula itself must stay fixed and non-discretionary. An employer that wants to reduce or suspend the percentage has to formally amend the plan document. You can’t quietly contribute less in a bad year and catch up later. This is where many sponsors learn that a money purchase plan’s rigidity cuts both ways: reliable for employees, hard on businesses with uneven revenue.

Vesting

Vesting determines when employees gain permanent ownership of the employer’s contributions. A money purchase plan must satisfy one of two ERISA minimum schedules:

Cliff vesting: the employee has 0% ownership until completing three years of service, then becomes 100% vested at once.
Graded vesting: ownership phases in over six years, starting at 20% after year two and increasing 20% each year until reaching 100% after year six.

Employers can vest faster than these minimums, and immediate vesting is common in smaller firms trying to attract talent. They cannot vest slower.⁹ When an employee leaves before fully vesting, the unvested portion is forfeited. Forfeitures can reduce future employer contributions or be reallocated to remaining participants, depending on what the plan document says.¹⁰

Getting Money Out

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 permit hardship withdrawals. This surprises participants who assume all workplace retirement accounts work the same way. They don’t.

Early Withdrawal Penalty

Distributions taken before age 59½ are subject to ordinary income tax plus an additional 10% early withdrawal penalty on the taxable portion.¹¹ A handful of exceptions eliminate the penalty, including permanent disability, certain medical expenses exceeding a threshold percentage of income, and qualified domestic relations orders. Beginning in 2026, penalty-free withdrawals of up to $2,600 are also available for long-term care insurance purchases.

Participant 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.¹² Loans generally have to be repaid within five years, with substantially level payments at least quarterly. Fall behind, and the outstanding balance becomes a taxable distribution, potentially with the early withdrawal penalty on top.

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.¹³ Rolling into a Roth IRA is also allowed, but the entire transferred amount becomes taxable income in the rollover year. 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 still working who don’t own 5% or more of the sponsoring company can generally delay RMDs until they actually retire.¹⁴ Missing an RMD triggers a steep excise tax on the amount that should have been withdrawn.

Ongoing Compliance for the Sponsor

Keeping a money purchase plan in good standing takes consistent administrative work. Every year the sponsor files a Form 5500 (or the shorter 5500-SF for plans with fewer than 100 participants) with the IRS and Department of Labor, reporting the plan’s financials, investments, and participant data. The deadline is the last day of the seventh month after the plan year ends — July 31 for calendar-year plans — with an extension available on Form 5558.¹⁵ Larger plans filing the full Form 5500 must include audited financial statements from an independent qualified public accountant.¹⁶

ERISA also requires every person who handles plan funds to be covered by a fidelity bond of at least 10% of the assets they handle. The minimum bond is $1,000 per plan; the maximum the DOL can require is $500,000, or $1,000,000 for plans that hold employer securities.¹⁷ The bond protects the plan against fraud or dishonesty by the people managing the money; it isn’t insurance for the plan’s investments.

Whenever the plan makes a distribution of $10 or more, the administrator issues a Form 1099-R to the recipient and files a copy with the IRS, reporting gross distribution, taxable amount, and any withholding.¹⁸

How It Compares to a Profit-Sharing Plan

The difference is flexibility. A profit-sharing plan lets the employer decide each year whether to contribute, how much, or whether to skip a year entirely. A money purchase plan locks in the rate. If the plan says 8%, the employer owes 8% of every eligible employee’s compensation, even in a year with no profit at all.

Both plan types share the same annual additions ceiling ($72,000 for 2026) and the same compensation cap ($360,000).² Both are defined contribution plans with the same core tax treatment: deductible employer contributions, tax-deferred growth, and ordinary income tax on distributions.

Money purchase plans were much more common before 2001. At the time, profit-sharing plans had a deductible contribution ceiling of only 15% of eligible compensation, while money purchase plans allowed deductions up to 25%. Employers who wanted to maximize contributions layered a profit-sharing plan on top of a money purchase plan to reach the higher combined ceiling. The Economic Growth and Tax Relief Reconciliation Act of 2001 raised the profit-sharing deduction limit to 25%, erasing the reason most employers put up with the fixed-contribution rigidity.¹⁹ Most new plans adopted since use profit-sharing or 401(k) structures.

Money purchase plans still have a niche. Employers that want to signal a firm retirement commitment to employees, and can absorb a fixed annual cost, may prefer the certainty. Employees benefit from knowing exactly what will be contributed each year rather than depending on a discretionary funding decision.

Terminating the Plan

An employer can terminate a money purchase plan, but not by simply stopping contributions. The employer formally amends the plan to establish a termination date and updates the document to reflect all current legal requirements as of that date.²⁰

On termination, every participant becomes 100% vested immediately, regardless of where they stood on the vesting schedule. An employee who was 40% vested the day before termination is fully vested the day of. The employer must distribute all plan assets as soon as administratively feasible, generally within a year. Until the assets are actually distributed, the plan is still considered ongoing and must keep meeting qualification and reporting requirements.²⁰

Participants must receive notice of their distribution options 30 to 180 days before the actual distribution date. Most will want to roll their balances into an IRA or a new employer’s plan to avoid an immediate tax bill. The sponsor can also request an IRS determination letter confirming the termination was handled correctly, though this step is optional. Skipping the correct procedures exposes the plan to the same excise taxes and disqualification risks that apply to an ongoing plan out of compliance.

1
Internal Revenue Service. COLA Increases for Dollar Limitations on Benefits and Contributions
2
Internal Revenue Service. Choosing a Retirement Plan: Money Purchase Plan
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eCFR. 26 CFR 1.415(c)-1 – Limitations for Defined Contribution Plans
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Internal Revenue Service. 2026 Amounts Relating to Retirement Plans and IRAs, as Adjusted for Changes in Cost-of-Living
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9
Internal Revenue Service. Retirement Topics – Vesting
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Office of the Law Revision Counsel. 29 U.S. Code 1053 – Minimum Vesting Standards
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Internal Revenue Service. Retirement Plans FAQs Regarding Loans
13
Internal Revenue Service. Rollover Chart
14
Internal Revenue Service. Retirement Plan and IRA Required Minimum Distributions FAQs
15
Internal Revenue Service. Form 5500 Corner
16
U.S. Department of Labor. Form 5500 Series
17
U.S. Department of Labor. Field Assistance Bulletin No. 2008-04
18
Internal Revenue Service. About Form 1099-R, Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc.
19
Internal Revenue Service. Chapter 2 Summary of EGTRRA and Recent Law Provisions
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Internal Revenue Service. Retirement Plans FAQs Regarding Plan Terminations