Back to Insights  /  Read More About Retirement Planning

Startup Retirement Plan Tax Credits: A Substantial Benefit You Might Not Know About

Jonathan Frawley, CRPS®, AIF®

06/25/2024

Do you know that the federal government will pay an employer to open a retirement plan for their employees? If you don’t, you’re far from alone. Responding to a recent survey by the National Association of Plan Advisors (NAPA), nearly three-quarters (72 percent) of small business owners said they were not aware of the tax credit.

Suppose you are a business owner, corporate executive, or an employee working for a company without a current retirement plan. In that case, the following article will reveal what you need to know about the Small Employer Retirement Plan Start-up Costs Tax Credit.

First, the credit isn’t exactly new. It was a provision of the SECURE Act of 2019, passed by Congress with bipartisan support and effective as of January 1, 2020. Congress later passed the SECURE Act 2.0, which expanded the tax credit for new plans beginning after December 31, 2022.

Eligible Employers

  • must have at least one non-highly compensated employee (NHCE)
  • must have had 100 or fewer employees who received at least $5,000 in compensation from the employer for the preceding year
  • must have not had a retirement plan of any kind during the prior three years

The four tax credits available

1. Plan Cost Credit:
The credit applies to costs paid by the employer to set up and administer the plan, such as recordkeeper fees, third party administrator (TPA) fees, and financial advisory fees. The credit does not apply to plan costs paid through plan assets or investment expenses; you must be billed or invoiced and pay with corporate funds.

If the company has 50 or fewer employees, the credit covers 100 percent of eligible startup costs. If the company has between 51 and 100 employees, the credit covers half of the eligible startup costs: up to $500, or the lesser of $250 per each NHCE eligible to participate in the plan up to a maximum of $5,000 (20 or more NHCEs).

You can claim the credit for each of the first three years of the plan, potentially $15,000 over the course of those three years. The credit is part of the general business credit and if it can’t be used in the current year, it can be carried back one year or forward 20 years.

2. Employer Contribution Credit:
What could amount to a substantial credit of $1,000 per employee can be claimed for employer contributions—examples include match, nonelective, safe-harbor, discretionary profit sharing—for non-owner employees with wages of $100,000 or less (adjusted for inflation).

If you have 50 or fewer employees:

  • Year 1: 100 percent of employer contributions
  • Year 2: 100 percent of employer contributions
  • Year 3: 75 percent of employer contributions
  • Year 4: 50 percent of employer contributions
  • Year 5: 25 percent of employer contributions

The credit begins to phase out for a business with 51 to 100 employees at a rate of 2 percent for each employee over 50. For example, if the business has 66 employees, the credit in year one would amount to 68 percent of employer contributions (100 percent minus 16 times 2 percent), as opposed to the full 100 percent.

Note that the business cannot claim both the credit and a deduction for the same expenses. Usually, plan costs and employer contributions are claimed as deductions. In this case, the credit comes first; any expense above and beyond the credit could be claimed as a corporate deduction.

3. Automatic Enrollment Credit:

If the retirement plan adds automatic enrollment to the plan document, the company can claim a tax credit of $500 per year for the first three years the provision is included. The credit is available for new or existing plans that adopt an eligible auto-enrollment plan.

Note that any 401(k) plan established after December 29, 2022, is required to use the automatic enrollment provision, per SECURE ACT 2.0.

4. Military Spouse Employees:

A qualified small business that employs a NHCE who is a military spouse can receive a credit of up to $500 for each spouse participating in the plan. This credit, however, is subject to several requirements, which can be found here.

Examples of how the credits work

Example #1:

  • Company ABC establishes a new 401(k) plan
  • 15 total employes (2 highly compensated owners; 13 NHCEs)
  • Automatic Enrollment
  • Safe Harbor Match with Discretionary Profit Sharing
    • Assume 13 employees each receive at least $1,000 and earn less than $100,000
  • Startup costs are as follows:
    • Recordkeeper               $2,900
    • TPA                                $1,745
    • Fiduciary Advisor        $2,500
    • Annual Totals               $7,145

Startup tax credit (13x$250) =            $3,250
Auto Enroll Credit =                              $500
Employer Contribution =                     $13,000

Credits from Tax Year 1 = $16,750
Credits from Tax Year 2 = $16,750
Credits from Tax Year 3 = $13,500
Credits from Tax Year 4 = $6,500
Credits from Tax Year 5 = $3,250

Total Credits for Company ABC over five-year span = $56,750

Example #2:

  • Company XYZ establishes a new 401(k) plan
  • 45 total employes (2 highly compensated owners; 43 NHCEs)
  • Automatic Enrollment
  • Safe Harbor Match with Discretionary Profit Sharing
    • Assume 43 employees each receive at least $1,000 and earn less than $100,000
  • Startup costs are as follows:
    • Recordkeeper              $5,000
    • TPA                                $2,135
    • Fiduciary Advisor        $2,500
    • Annual Totals              $9,635

Startup tax credit (43x$250) =  $5,000 (limit reached)
Auto Enroll Credit =                     $500
Employer Contribution =            $43,000

Credits from Tax Year 1 = $48,500
Credits from Tax Year 2 = $48,500
Credits from Tax Year 3 = $37,750
Credits from Tax Year 4 = $21,500
Credits from Tax Year 5 = $10,750

Total Credits for Company XYZ over five-year span = $167,000

Note: Remember that you can still deduct the expenses above what the credit covers.

The information on this page is only intended for educational purposes to show an example of this type of offering. 

How are the credits claimed?

Credits can be claimed by filing IRS Form 8881. There are more in-depth instructions for completing the Credit for Small Employer Pension Plan Start-Up Costs made available. The credits are also available for other defined contribution plans, such as a SEP IRA or a SIMPLE IRA, but a 401(k) profit-sharing plan or 403(b) plan is likely to generate the largest credit amount.

Retirement plans offer many unique employer and employee benefits. HBKS Wealth Advisors maintains a dedicated team of professionals who work solely on employer-sponsored retirement plans of all sizes. Working Together with our HBK CPAs & Consultants colleagues, we are focused on maximizing tax efficiencies for our clients.

We’re here to help you make informed decisions about your current or future retirement plan. Call us at 1-866-536-5776 or email me for more information at jfrawley@hbkswealth.com.

IMPORTANT DISCLOSURES
The information included in this document is for general, informational purposes only. It does not contain any investment advice and does not address any individual facts and circumstances. As such, it cannot be relied on as providing any investment advice. If you would like investment advice regarding your specific facts and circumstances, please contact a qualified financial advisor.

Any investment involves some degree of risk, and different types of investments involve varying degrees of risk, including loss of principal. It should not be assumed that future performance of any specific investment, strategy or allocation (including those recommended by HBKS® Wealth Advisors) will be profitable or equal the corresponding indicated or intended results or performance level(s). Past performance of any security, indices, strategy or allocation may not be indicative of future results.

The historical and current information as to rules, laws, guidelines or benefits contained in this document is a summary of information obtained from or prepared by other sources. It has not been independently verified, but was obtained from sources believed to be reliable. HBKS® Wealth Advisors does not guarantee the accuracy of this information and does not assume liability for any errors in information obtained from or prepared by these other sources.

HBKS® Wealth Advisors is not a legal or accounting firm, and does not render legal, accounting or tax advice. You should contact an attorney or CPA if you wish to receive legal, accounting or tax advice.


Speak to an Advisor

First Name*
 
 
 
 
Last Name*
 
 
 
 
Email Address*
 
 
 
 
Phone Number*
 
 
 
 
Zip*
 
 
 
 
Message