Money Purchase Plan - Retirement Savings with Employer Contributions

1. What Is It? A qualified retirement plan where: • each employee has an individual account • employer contributes to employee account • plan benefits are result of employer contributions, interest or other investment return and capital gains • employee account balance may be paid out as an annuity equivalent in value to account balance

2. When is it Indicated? 1. employer wants a qualified plan that is simple to administer and explain to employees 2. relatively young employees with time to accumulate $ 3. employees willing to accept investment risk 4. some retirement income security desired 5. employer wants to reward long-term employees

3. Advantages • tax deferred savings • plan simple and inexpensive to design, administer, explain to employees • plan formula typically allows up to 25% employee compensation, with contribution not exceeding $49,000 (2009, indexed) • certain lump sum distributions may qualify for 10-year averaging • participants benefit from good investment results

4. Disadvantages • retirement benefits may be inadequate for older plan entrants; disparity between short and long term employees reduced somewhat by salary increases • annual addition to each employee account limited to • lesser of $49,000 (2009, indexed) 0R 100% compensation • $245,000 cap on compensation • employees bear investment risk • employer must make plan contributions each year or face minimum funding penalties

5. Design Features • benefit formulas • flat % of employee compensation – up to 15% (typical) • service-related factors • favors older, higher compensated • may lead to prohibited discrimination in closely held or professional corporations

6. Design Features • only first $245,000 of employee’s compensation can be considered in the plan formula • to avoid discrimination can • comply with safe harbor rules under IRC Section 401(a)(4) • satisfy a general nondiscrimination test • restructure plan • use cross-testing

7. Design Features • plan benefit formula can be ‘integrated’ with Social Security • vesting schedules permitted by IRC can be used • benefits usually paid at termination of employment or plan’s stated normal retirement age

8. Design Features • no ‘in-service’ distributions unless due to employee death or disability, severance of employment or termination of the plan • money purchase plan funds • generally invested in pooled account managed by employer or fund manager designated by employer • can be in trust fund or group or individual life insurance contracts

9. Tax Implications As a qualified plan • employer contributions tax deductible when made • plan contributions tax deferred for employee IRC Section 415 limits apply • annual additions to each account lesser of 100% employee compensation or $49,000 (indexed)

10. Tax Implications Annual additions include • employer contributions to participant account • forfeitures from other participant accounts • employee contribution to the account Plan distributions must follow rules for qualified plans Lump sum distributions may be eligible for special 10 year averaging

11. Tax Implications Plan must meet IRC Section 412 minimum funding rules; including annual contributions Certain employers eligible for $500 business tax credit for “qualified start up costs” Plan may permit employees to make voluntary contributions to “deemed IRA” under plan Plan subject to ERISA reporting and disclosure rules

12. Alternatives Target benefit plans • employer contribution % can be based on age at plan entry • may be more favorable for older employees Profit sharing plans • give employer more flexibility in contributions • give employees less security

13. Alternatives Defined benefits plans • give employees more security • provide larger contributions for older employees • more complex to design and administer Nonqualified deferred compensation plan • can provide for select executives • employer tax deduction delayed until benefit payments made

14. Alternatives Individual savings plans • IRAs allow tax deferral • contribution limits may be too low for some employees • tax deduction phased out for higher income individuals

15. True or False? • Each employee has an individual account in a money purchase plan. • A money purchase plan will typically provide older workers with sufficient retirement income. • The employer bears investment risk in a money purchase plan. • Money purchase plan contributions are typically based on a flat percentage of employee compensation at all salary levels.

16. True or False? • Using service related factors in a money purchase plan benefit formula will generally help the employer avoid violating the nondiscrimination rules applied to qualified plans. • Money purchase plans are generally invested in a pooled account managed either by the employer (though a trustee or insurance company) or fund manager designated by the employer.

17. True or False? • An integrated plan provides a higher rate of employer contribution level above the integration level than below the integration level. • Forfeitures in a money purchase plan can only be used to reduce future employer contributions.

18. True or False? • Money purchase plans provide for participant plan balance at retirement to be converted to an equivalent annuity. • A money purchase plan is subject to ERISA reporting and disclosure rules.

19. Discussion Question What are the advantages and disadvantages of a self-employed person or a shareholder-employee in an S corporation utilizing a money purchase pension plan?