While workers participating in retirement plans benefit from features like auto-enrollment, auto-escalation, and default investment options, many of those employed by smaller companies do not have access to a plan.
Small businesses, defined as those with 100 employees or less, represent over 97% of companies in the United States and employ roughly one-third of all workers. Offering a retirement plan can be challenging because of the cost of establishing and maintaining a plan. In response, Congress has taken steps to incent smaller businesses to sponsor plans. The SECURE 2.0 legislation includes an enhanced tax credit for establishing a plan and a new credit to help offset employer contributions to a plan.
Larger firms are more likely to offer workplace savings
Source: Bureau of Labor Statistics, 2019, most recent data available.
What types of plans are eligible for the startup plan tax credit?
The tax credit applies to companies with no more than 100 employees and includes SEP, SIMPLE IRA, and qualified retirement plans like a 401(k). New defined benefit plans are also eligible for the tax credit. The enhanced version of the tax credit under SECURE 2.0 is available to businesses with 50 or fewer employees.
Can a business owner claim the credit for upgrading from an existing SIMPLE IRA plan to a 401(k)?
Unfortunately, no. The tax credit is only available if employees covered by the new plan have not been generally covered by another plan offered by the employer within the last three years. However, if the new 401(k) plan includes an auto-enrollment provision, there may be a separate tax credit available ($500 annually for three years).
How is the startup plan tax credit calculated?
SECURE 2.0 enhances the existing tax credit for those with 50 employees or fewer by covering 100% of administrative costs for the first three plan years, for a maximum of $5,000 annually. For businesses with more than 50 and up to 100 employees, the tax credit remains at 50% of administrative costs up to $5,000. The tax credit also takes into account how many non-highly compensated employees (non-HCEs) the plan covers. For 2023, those with compensation exceeding $150,000 are considered highly compensated.
Here’s how the annual calculation applies (50 employees or less):
THE CREDIT = LESSER OF:
(a) 100% of plan administrative costs (maximum of $5,000)
OR
(b) $250 per non-HCE covered by the plan (minimum of $500)
How does the new tax credit under SECURE 2.0 apply for startup retirement plans making employer contributions into participant accounts work?
- SECURE 2.0 provides a new tax credit of up to $1,000 per plan participant for businesses with 50 employees or less
- Tax credit is reduced by 25% each year until it is no longer available five years from being initially claimed (e.g., 100% in year 1, 75% in year 2, 50% in year 3, and 25% in year 4)
- For businesses with more than 50 employees and less than 100 employees, the tax credit is gradually phased out
- The tax credit cannot be claimed for employees with more than $100,000 in compensation (indexed for inflation)
- Contributions into defined benefit plans are not eligible for the tax credit
Opportunity for smaller businesses
The new and enhanced tax credits offer business owners a significant financial incentive to boost savings for themselves and their employees. This type of employee benefit can also help retain and attract talent. Another factor is that many states are mandating that certain employers without retirement plans adopt a state-run savings program. These are typically established as Roth IRAs, funded through payroll deduction. While provisions will vary by state, employers who don’t offer a retirement plan and refuse to adopt the state-managed program face a financial penalty. If a business owner is facing this type of mandate anyways, why not establish a more comprehensive plan and take advantage of the tax credits available?
Financial professionals: Join our March 15 webinar, “Ideas to engage clients during tax season,” for a discussion of actionable wealth planning ideas.
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