Money Purchase Pension Plan

Vantry Foods is choosing between a profit-sharing plan and a money purchase pension plan for its employees. Which statement correctly distinguishes the two?

1. A.A money purchase plan promises each participant a stated monthly benefit at retirement, while a profit-sharing plan does not.Wrong. That describes a defined BENEFIT plan. A money purchase plan fixes the contribution going in, never the benefit coming out.
2. B.Only the profit-sharing plan is qualified; a money purchase pension plan is a nonqualified arrangement.Wrong. Both are qualified plans eligible for pre-tax employer contributions and tax-deferred growth.
3. C.A profit-sharing plan requires an annual contribution equal to a set percentage of profits, while a money purchase plan is discretionary.Wrong - this reverses the two. Despite the name, a profit-sharing plan's contribution is discretionary and need not be tied to profits at all.
4. D.A money purchase plan commits the employer to a fixed contribution formula every year, while a profit-sharing plan lets the employer set the amount annually - including nothing at all.Correct. Mandatory versus discretionary funding is the distinguishing feature. Both remain defined contribution plans.

Why: Both are qualified DEFINED CONTRIBUTION plans, so both define the employer's input rather than the participant's eventual benefit. The difference is whether that input is mandatory. A money purchase pension plan locks the employer into a fixed contribution formula - a stated percentage of each participant's compensation - which must be funded every year regardless of profits. A profit-sharing plan leaves the amount to the employer's discretion each year, and the employer may contribute nothing in a lean year. The trade-off is predictability for the employee versus flexibility for the employer.

Zora Petrossian participates in her employer's traditional defined benefit pension plan, which promises a monthly retirement benefit based on her final average salary and years of service. Which statement correctly describes this plan?

1. A.Zora bears the investment risk, and her pension is whatever her individual account balance will purchase at retirementThat describes a defined contribution plan, not a defined benefit plan.
2. B.The promised benefit is insured by the Securities Investor Protection CorporationSIPC covers customers of failed broker-dealers, not pension promises. The PBGC is the pension insurer.
3. C.The employer's annual funding is capped at the elective deferral limit that applies to 401(k) plansElective deferral limits govern salary-reduction plans; defined benefit funding is actuarially determined.
4. D.The employer bears the investment risk and must fund the formula benefit actuarially, and the benefit is insured up to statutory limits by the Pension Benefit Guaranty CorporationCorrect. Defined benefit plans shift investment risk to the employer and are PBGC-insured within limits.

Why: In a defined benefit plan the promise is the benefit, not the contribution. The employer, guided by an actuary, must fund the plan so the formula benefit can be paid, and the employer therefore bears the investment risk: poor returns increase the required contributions rather than reducing the participant's pension. Benefits of covered private-sector defined benefit plans are insured by the Pension Benefit Guaranty Corporation up to statutory limits.