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.
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