What is a Money Purchase Plan? Unlocking 401(h) Benefits
Discover how a Money Purchase Plan works and its unique ability to integrate a 401(h) account for tax-advantaged retiree health benefits. Learn if this powerful combination is right for your retirement strategy.
Contents
Key takeaways
- A Money Purchase Plan is an employer-funded defined contribution retirement plan with mandatory contributions.
- Paired with a 401(h) account, it allows pre-tax contributions for retiree medical expenses.
- Contributions to the 401(h) are capped and must be incidental to the pension contributions.
- This setup offers tax advantages for both employers and high-income employees/owners.
- Ideal for business owners seeking to fund both retirement and future healthcare costs tax-efficiently.
Understanding the Money Purchase Plan
A Money Purchase Plan (MPP) is a type of defined contribution retirement plan. Unlike some other plans where contributions might be discretionary, an MPP requires an employer to contribute a fixed percentage of each eligible employee's compensation every year. This commitment makes it a predictable savings vehicle.
- **Defined Contribution:** Contributions are fixed, but the eventual retirement benefit depends on investment performance.
- **Employer Funded:** Contributions come solely from the employer, not employee deferrals.
- **Mandatory Contributions:** The employer must adhere to the predetermined contribution formula, regardless of company profitability.
Money Purchase Plan vs. Profit Sharing Plan
While both Money Purchase Plans and Profit Sharing Plans are defined contribution plans, a key distinction lies in their contribution structure. Profit Sharing Plans offer flexibility, allowing employers to vary contributions year-to-year, often based on company profits.
In contrast, Money Purchase Plans demand a consistent, predetermined contribution. This commitment can be advantageous for some businesses, but also requires careful financial planning. The commitment in an MPP is also what historically allowed it to be paired with a 401(h) account.
- **Money Purchase Plan:** Fixed, mandatory employer contributions.
- **Profit Sharing Plan:** Flexible, discretionary employer contributions, often tied to company performance.
The Unique Role of the 401(h) Account
A 401(h) account is a special medical benefit account that can be attached to a pension or annuity plan—specifically, defined benefit plans or certain defined contribution plans like the Money Purchase Plan. It allows employers to set aside pre-tax funds to pay for healthcare expenses for retirees, their spouses, and dependents.
This unique pairing differentiates an MPP from many other retirement vehicles, offering a dual benefit of retirement income and healthcare savings. The ability to fund retiree medical expenses through a tax-advantaged vehicle like a 401(h) is particularly attractive for business owners and high-income earners planning for their future healthcare costs.
How 401(h) Contributions Work
Contributions made to the 401(h) account are generally tax-deductible for the employer and grow tax-free. When distributions are made for qualified medical expenses in retirement, they are typically tax-free to the retiree.
However, there are strict rules governing how much can be contributed to a 401(h). The contributions for medical benefits must be "subordinate" or "incidental" to the retirement benefits provided by the main plan. Typically, this means 401(h) contributions cannot exceed 25% of the aggregate contributions made to the pension portion of the plan since the 401(h) was established.
Benefits for Business Owners and High-Income Earners
For business owners and high-income individuals, the combination of a Money Purchase Plan and a 401(h) account presents a powerful strategy for tax-advantaged savings.
It allows for significant contributions to both retirement and healthcare, potentially reducing current taxable income and providing a robust financial safety net for the future. The ability to pre-fund retiree medical expenses is a substantial benefit, especially given the rising costs of healthcare.
- **Tax-Deductible Contributions:** Employer contributions to both the MPP and 401(h) are generally tax-deductible.
- **Tax-Free Growth:** Funds within both accounts grow tax-deferred.
- **Tax-Free Medical Distributions:** Qualified medical distributions from the 401(h) are typically tax-free.
- **Estate Planning:** Funds remaining in a 401(h) after the retiree's death can often be used by beneficiaries for qualified medical expenses.
Is a Money Purchase Plan with 401(h) Right for You?
Deciding if a Money Purchase Plan with an integrated 401(h) account is suitable for your situation requires careful consideration of your business structure, financial goals, and retirement objectives. It's particularly appealing for businesses with stable cash flow that can commit to the mandatory contributions of an MPP.
If you're a small business owner, a doctor, or a high-income earner looking for robust retirement savings combined with a tax-efficient way to fund future healthcare costs, exploring this option with a qualified financial advisor is highly recommended. The complexities of IRS regulations surrounding 401(h) accounts necessitate expert guidance to ensure compliance and maximize benefits.
Frequently asked questions
Availability, tax treatment, and plan design depend on the facts and circumstances of the employer, plan document, participant group, and applicable law. 401h.com provides general educational information only — not tax, legal, actuarial, investment, or ERISA advice. Consult qualified tax, legal, actuarial, and plan professionals.
401h.com Editorial
401h.com
The 401h.com editorial team publishes plain-English explainers on 401(h) retiree medical benefit plans. Educational only — not tax, legal, actuarial, investment, or ERISA advice.
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