Before retirement plan provisions of the Economic Growth and Tax Relief Reconciliation Act (EGTRRA) took effect on Dec. 31, 2001, the choice between money purchase and profit-sharing plans was fairly clear.
Money purchase plans allowed employers to deduct up to 25% of the aggregate taxable compensation of employees covered by the plan, provided employers agreed to make required annual contributions for all eligible employees. Profit-sharing plans allowed more flexibility in employer contributions. In any given year, employer contributions could drop as low as zero, but the maximum deduction was limited to 15% of aggregate taxable compensation.
This made money purchase plans preferable in many companies with steady year-to-year profits and a desire to set aside as much money as possible for owners and other highly compensated employees (HCEs). On the other hand, profit-sharing plans were favored by companies that wanted more flexibility in year-to-year funding.
EGTRRA raised the employer deduction ceiling in profit-sharing plans from 15% to 25% — the same as in money purchase plans.
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For profit-sharing plans with a 401(k) elective deferral feature, EGTRRA also excluded participants’ elective deferrals from the 25% ceiling.
Finally, in all defined contribution plans (money purchase or profit-sharing), maximum annual contributions per participant were raised to the lesser of $40,000 (as indexed) or 100% of compensation.
Why more conversions and mergers?
As a result of these changes, it appears that profit-sharing plans can now achieve the same goals as money purchase plans, with more year-to-year funding flexibility. Therefore, many older money purchase plans have converted to profit-sharing.
Also, some companies that offered both money purchase and profit-sharing plans are merging the two plans into a single profit-sharing plan.
But for some companies, such a conversion or merger could prove costly. This provision involves stringent participant notification requirements under Section 204(h) of ERISA. You may want to become familiar with the process for monitoring money purchase-to-profit-sharing plan conversions or mergers in your market, so that you can make plan sponsors aware of notification requirements.
Step 1: The first step is to monitor FreeERISA’s 5310 database for recent “open” listings in your market. The 5310 “open” listings give you the name, address and EIN of a company that has filed for an application of (tax-qualified) determination. In many cases, plans that are converting from money purchase to profit-sharing formats (or merging two plans into one) will seek such a determination and become visible in this database. However, the 5310 data does not explicitly identify a money purchase plan.