A money purchase pension plan operates like a profit sharing plan. The major difference is that, unlike profit sharing plans where employers are permitted to make discretionary contributions each year, the employer has a set contribution rate which is stated in the plan document. These mandatory contributions must be made each year regardless of the employer's profits. Failure to make a contribution can result in the imposition of penalties.
Contributions are generally based on a fixed percentage of each employee's compensation. For tax deduction purposes, the company contribution cannot exceed 25% of compensation to a maximum annual limit ($49,000 in 2009 and $49,000 in 2010). The contribution may be integrated with Social Security which results in larger contributions for higher paid employees.
Prior to the Economic Growth and Tax Relief Reconciliation Act of 2001 ("EGTRRA"), profit sharing plans were limited to 15% of compensation while money purchase plans were permitted to make contributions as high as 25%. A combination money purchase pension plan and profit sharing plan was sometimes used to limit mandatory contributions while retaining the ability to make larger contributions in good years. The increased profit sharing deduction limit gives employers the ability to make larger contributions to profit sharing plans and may render the money purchase pension plan obsolete.