Before retirement plan provisions of the Economic Growth and Tax Relief Reconciliation Act (EGTRRA) took effect on 12/31/01, 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. 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.

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