Tax credits for small employer retirement plans

Author: Penelope Team
Tax credits for small employer retirement plans

As a small business, concerns about the costs associated with offering a retirement savings plan can often delay or derail the implementation of this important employee benefit.

The good news, however, is that there are many low-cost retirement plan options available for small businesses, And equally importantly, there are tax benefits available for businesses that offer a retirement plan. The federal government offers three tax credits in particular that are designed to make it far more financially attractive for businesses to adopt a retirement savings program for employees.  

If you’re not familiar with all of the tax credits available or are unsure whether your business is eligible, read on to find out more.

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The Role of SECURE and SECURE 2.0

Because the federal government wants employers to offer retirement savings programs, it has passed two laws in recent years designed to further increase and enhance tax credits for businesses. The first law, aimed at providing more valuable tax credits, is known as the SECURE Act and it was adopted in December 2019 and took effect in 2020. That was followed by the passage SECURE 2.0 in 2022, through which the federal government enhanced tax credits even further to make it still more financially accessible for small businesses to offer a retirement plan.

The most well-known tax credit made available through the federal government's efforts with SECURE and SECURE 2.0 is perhaps the start-up credit, but it is only one of the valuable tax benefits to be aware of. Here’s a closer look at the range of credits available to small businesses offering retirement plans.

Start-up Tax Credit

Naturally, there are various costs associated with initiating a 401(k) retirement plan for your business, or SEP or SIMPLE IRA. These costs include expenses associated with establishing and administering the plan and educating employees about the retirement program features.

As the National Association of Plan Advisors (NAPA) explains, under the SECURE Act the tax credit available to small businesses to offset start-up costs was: 

“The greater of: (1) $500, or (2) the lesser of: (a) $250 for each employee of the eligible employer who is not a highly compensated employee and who is eligible to participate in the eligible employer plan maintained by the eligible employer, or (b) $5,000.”

This credit was available up to 50 percent of eligible expenses, NAPA goes on to explain. And essentially provided a minimum credit of $500 and a maximum credit of $250 times the number of non-highly compensated employees up to no more than $5,000.

The Secure Act 2.0 came along, however, and raised the tax credit from a maximum of 50 percent of start-up costs to a full 100 percent of a business’s start-up costs when adopting a retirement plan. The annual maximum under the new SECURE 2.0 provision (which just came into effect in January 2023), remains at $5,000.

The important takeaway here is that these tax credits make it practically free to set up and administer a retirement plan for the first three years, as these costs for a small business rarely exceed $5,000.

However, there are important eligibility requirements to be aware of as a small business owner.

Eligibility requirements

According to the IRS, qualifying employers include those that: 

  • Had 100 or fewer employees who received at least $5,000 in compensation from your business the preceding year
  • Businesses that had at least one plan participant who was a non-highly compensated employee; and
  • A business that in the three tax years before the first year of being eligible for the tax credit, had employees who weren’t substantially the same employees who received contributions or accrued benefits in another plan sponsored by you, a member of a controlled group that includes you, or a predecessor of either.

The American Society of Pension Professionals & Actuaries sums eligibility up more succinctly, explaining: “An employer is eligible for the tax credit if the employer had no more than 100 employees making at least $5,000 in the prior year and did not maintain a 401(a), 403, SIMPLE, or SEP plan in the three taxable years immediately preceding the tax year in which the plan is adopted.”

It’s important to note however that businesses claiming the start-up tax credit, cannot also deduct their retirement plan start-up expenses on tax returns.

Claiming the tax credit requires filing IRS Form 8881, Credit for Small Employer Pension Plan Startup Costs.

Automatic Enrollment Credit

With the passage of the SECURE Act, the federal government also created an automatic enrollment credit for small businesses that offer retirement programs, according to NAPA.

Through this measure, any eligible employer that adds an auto-enrollment feature to a new or existing retirement plan can claim a tax credit of $500 per year for up to three years after adding this new feature, according to the IRS.

Employer Contribution Cost Credit

Yet another credit available to businesses as a result of SECURE 2.0 is the credit for employers who provide contributions to their employees’ savings efforts. Similar to the start-up costs tax credit, businesses must meet eligibility requirements to receive this credit. 

The American Society of Pension Professionals & Actuaries provides a helpful table that breaks down the application of this particular tax credit for small businesses.

Years Since Plan Adoption

Tax Credit

1-50 employees

Tax Credit

51-100 employees

Maximum Credit

Year of Adoption*

100% of eligible employer contribution

Same minus 2% times number of employees over 50

Lesser of actual employer contribution or $1,000 for each employee making $100,000 or less in FICA wages

1st tax year after adoption

100% of eligible employer contribution

Same minus 2% times number of employees over 50

Lesser of actual employer contribution or $1,000 for each employee making $100,000 or less in FICA wages

2nd tax year after adoption

75% of eligible employer contribution

Same minus 1.5% times number of employees over 50

$0 for each employee making >$100,000 in FICA wages

3rd tax year after adoption

50% of eligible employer contribution

Same minus 1% times number of employees over 50

$0 for each employee making >$100,000 in FICA wages

4th tax year after adoption

25% of eligible employer contribution

Same minus 0.5% times number of employees over 50

$0 for each employee making >$100,000 in

Source: American Society of Pension Professionals & Actuaries

Overview of tax credits 

Given the various tax credits available and their eligibility requirements, it can be confusing to keep on top of it all. Here too, the American Society of Pension Professionals & Actuaries provides a helpful overview of the tax credits available to small businesses thanks to the passage of the SECURE Act 2.0.

Size of Employer*

Start-Up Cost Tax Credit

Employer Contribution Tax Credit

Automatic Enrollment Credit

1 - 50 employees

100% of Eligible Start-up Costs

Up to 100% employer contribution for first 2 years;

75% in third year;
50% in fourth year;
25% in fifth year

$500

51 – 100 employees

50% of Eligible Start-up Costs

Same as above, but phased out based on number of employees above 50

$500

100+ employees

0% of costs

$0

$0

Notes

Available for first three tax years plan is maintained. 

Maximum credit is lesser of $5,000 or $250 times the number of eligible non-highly compensated employees.

Available for first five tax years plan is maintained.

Credit available only for contributions for employees that make $100,000 or less in FICA wages.

Maximum credit per employee is $1,000.

Available for first three tax years plan offers an eligible automatic contribution arrangement.

Source: American Society of Pension Professionals & Actuaries

The takeaway

The valuable tax credit enhancements provided through the SECURE Act and SECURE Act 2.0 are a valuable financial benefit for small businesses offering a retirement plan. For businesses with 50 employees or less, the start-up tax credit has the potential to offset the first three years of start-up and administration costs entirely. The important takeaway is that these credits make it cheaper than ever to offer your employees an incredibly valuable benefit. 

With the right plan and partner, businesses can benefit from improved employee engagement and loyalty while helping them build their retirement savings. Get started today with a free, no-obligation consultation with a 401(k) retirement specialist.

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