An Employer’s Guide to Retirement Plan Tax Credits
An Employer’s Guide to Retirement Plan Tax Credits
Did you know that your business may be eligible for thousands of dollars in tax credits? If you're launching a retirement plan or making employer contributions, you may be able to take advantage of these tax credits.
The SECURE Act 2.0 is a set of bipartisan legislation passed by Congress in December of 2022 that aims to boost retirement savings nationwide. It includes new tax incentives for businesses when starting a plan for their employees.
This article will guide you through these tax credits and how they work.
An Overview of the SECURE Act 2.0’s Tax Credits
As part of SECURE 2.0, there are three main tax credits available to certain businesses starting a retirement plan.
What Is a Tax Credit?
A tax credit is a dollar-for-dollar amount that reduces the amount of tax owed by an individual or a business. Unlike a tax deduction, which lowers taxable income, a tax credit directly decreases the overall tax bill. For example, a $1,000 tax credit will lower your tax bill by $1,000.
Here is an overview of the tax credits to be aware of:
- The Startup Credit: This boosts the existing start-up credit by increasing it from 50% to 100% of qualifying start-up expenses, with an annual limit of $5,000 for employers.
- The Auto-Enrollment Credit: This maintains an existing auto-enrollment credit, which permits eligible employers who add auto-enrollment to their plan to claim a tax credit of $500 per year for up to three years.
- The Employer Contribution Tax Credit: This is a new credit for employer contributions. Businesses can receive tax credits of up to $1,000 for each eligible employee per year for five years.
Below, we will dive into each tax credit, explain how they work, and discuss which businesses are eligible for each.
1. The Startup Credit
What Is It and How Does It Work?
Businesses can receive a tax credit for certain costs associated with starting and operating a new plan.
The Startup Credit is up to $5,000 per year for the first three years, designed to help businesses offset the costs of starting a retirement plan. It covers “qualified startup costs” which may include recordkeeping fees, plan administration fees, support services from your retirement vendor, and costs of educating your employees about the plan.
Depending on the number of employees a business has, they may be eligible for either a credit of 100% of qualifying expenses, or 50% of qualifying expenses. Here is a breakdown of the credit based on a business’s employee count:
| For Employers With 50 or Less Employees | For Employers With 51 to 100 Employees | |
|---|---|---|
| Startup Credit | Credit of 100% for qualifying expenses, up to $5,000 annually | 50% credit for the first $10,000 of qualifying expenses, up to $5,000 annually |
How Much Is the Credit?
Businesses could receive up to $15,000 over three years. The credit is capped at $5,000 per year but can be calculated as $250 times the number of non-highly compensated employees (NHCEs) eligible to participate in the plan.
What Is a Non-Highly Compensated Employee (NHCE)?
An NHCE is anyone in the business who is not defined as a highly compensated employee (HCE). An HCE is an individual who:
- Owned more than 5% of the business at any time during the current year or the preceding year, regardless of how much compensation that person earned or received, or
- Received compensation from the employer in excess of a specified threshold, defined by the IRS, in the preceding year. For 2023, the threshold is $150,000.
What Are the Requirements for Claiming the Startup Credit?
The requirements for claiming the Startup Tax Credit are as follows:
- You had 100 or fewer employees who received at least $5,000 in compensation from you for the preceding year.
- You had at least one participating employee who was a non-highly compensated employee (NHCE).
- In the three tax years before you became eligible for the credit, your employees weren’t enrolled in another plan sponsored by you, a member of a controlled group that includes you, or a predecessor of either.
- Complete IRS form 8881 with your tax professional.
2. The Auto-Enrollment Credit
What Is It and How Does It Work?
The Auto-Enrollment Credit is a tax incentive that encourages businesses to include an automatic enrollment feature in their retirement plans. This feature helps increase employee participation by automatically enrolling eligible employees in the plan unless they opt out.
How Much Is the Credit?
The Auto-Enrollment Credit is $500 per year and can be claimed for up to three years, for a total maximum credit of $1,500. This credit is in addition to any other retirement plan tax credits that the business may be eligible for.
What Are the Requirements for Claiming the Auto-Enrollment Credit?
The requirements for claiming this tax credit are as follows:
- Amend your plan to have an auto-enrollment feature.
In contrast to the Startup Credit, the Auto-Enrollment Credit is also available to businesses with existing retirement plans. For example, if your business has had a 401(k) plan for the last 10 years without auto-enrollment, you can still qualify for the Auto-Enrollment Credit by adding an auto-enrollment feature to your plan, assuming you meet all other eligibility requirements.
3. The Employer Contribution Tax Credit
What Is It and How Does It Work?
The Employer Contribution Tax Credit is designed to incentivize businesses to make contributions to their employees' retirement plans. This credit helps offset the cost of employer contributions, making it more feasible for businesses to support their employees' retirement savings goals. Credits are earned only for contributions made to participating employees’ accounts who make an annual salary of $100,000 or less.
Similar to the Startup Credit, the Employer Contribution Credit has varying outcomes, depending on the number of employees a business has. The credit remains the same for the first two years and phases out over the next three years. Here is a breakdown of the credit for businesses with 50 or less employees:
| Credits for Years 1 and 2 | Credit for Year 3 | Credit for Year 4 | Credit for Year 5 | |
|---|---|---|---|---|
| Credits for Employers With 50 or Less Employees | 100% of employer contributions, up to $1,000 per employee | 75% of employer contributions, up to $1,000 per employee | 50% of employer contributions, up to $1,000 per employee | 25% of employer contributions, up to $1,000 per employee |
How Much Is the Credit?
The maximum credit amount is up to $1,000 per participating employee per year for five years. This credit is in addition to any other retirement plan tax credits that the business may be eligible for.
What Are the Requirements for Claiming the Employer Contribution Credit?
The requirements for claiming this tax credit are as follows:
- You had less than 100 employees who received at least $5,000 in compensation from you for the preceding year.
- You had at least one participating employee who was a non-highly compensated employee (NHCE).
- In the three tax years before you became eligible for the credit, your employees weren’t enrolled in another plan sponsored by you, a member of a controlled group that includes you, or a predecessor of either.
- You make employer contributions to your employees' retirement plans.
Conclusion
For employers, launching a retirement plan has never been easier, and the potential tax credits can offset the costs. These plans not only help retain and recruit top talent but also demonstrate a commitment to the financial well-being of employees.
