Qualified Retirement Plans like Profit Sharing and Money Purchase Plans are types of retirement plans that are funded by the employer. They allow employers to contribute to an employee's account, while offering them business tax deductions and tax-deferred savings.
How the Profit Sharing Plan works
Profit Sharing Plans are designed for companies with fluctuating or uncertain profits. These plans can be established by sole proprietors, partnerships, or corporations. Companies can make a discretionary contribution of up to 15% of an eligible employee's total compensation. In a Profit Sharing Plan, the employer has the flexibility to determine the contribution amount each year. Contributions do not have to be dependent on profits. Contributions by the employer are tax deductible as a business expense and are not treated as taxable income to the employee.
How the Money Purchase Plan works
With Money Purchase Plans, the employer's contribution is mandatory. The contributions are usually based on each employee's compensation. The employer sets specific eligibility and vesting requirements, including contributions. This amount can be as high as 25% of total compensation or $30,000 whichever is lower. Money Purchase Plans are less flexible than Profit Sharing Plans because contributions must be made even if the company has no profits.
Profit Sharing & Money Purchase Combination
Many companies choose to implement both of these types of plans in conjunction with one another. This allows for a greater total contribution percentage. By combining these two types of plans, an employer can effectively contribute 25%, up to $30,000. A typical example of how this works is an employer making a 10% mandatory Money Purchase contribution and a discretionary 15% contribution into the Profit Sharing Plan. This type of approach offers some flexibility while maximizing the potential contribution percentage.
