Question

How does a profit sharing plan differ from a money purchase plan? Under what circumstances, and from whose point of view, would a profit sharing plan be better than a money purchase plan?

Answer 1

A money purchase pension plan operates like a profit sharing plan, however the main difference is that, unlike profit sharing plans where employers are can determine each year how much will be distributed to employees, the employer has a set rate of contribution which is notified in the plan document. Instead of a fixed percentage of salary, a profit-sharing employer is allowed to share a fixed amount of profit, and distribute among the employees every year as a percentage of salary. The money purchase plans make budgeting and planning for contributions simpler for the employer, while profit-sharing plan provides more flexibility in less profitable years.

An employer would prefer to establish a profit sharing plan instead of a money purchase pension plan. The reason is that the profit sharing plan does not have the mandatory funding requirements of the money purchase pension plan.