Offering a retirement plan is a valuable way to invest in your employees’ financial futures while strengthening your business’s ability to attract and retain talent. However, for many small business owners, the costs associated with establishing and maintaining a plan can be a concern. Fortunately, several federal tax credits are available to help eligible employers offset these expenses, encourage employee participation, and make retirement benefits more accessible. Understanding these incentives can help you make informed decisions about your business’s retirement plan offerings.
Eligibility for the credit
Offering a 401(k) plan can help your business retain current employees, attract new talent, and provide valuable tax benefits. You may qualify for the small employer pension plan startup costs tax credit if you had 100 or fewer employees who received at least $5,000 in compensation during the preceding year and at least one plan participant who is a non-highly compensated employee (NHCE). Additionally, your employees must not have been substantially the same employees who received contributions or accrued benefits under another retirement plan sponsored by your business, a related business within your controlled group, or a predecessor during the three tax years before your first year of eligibility.
Amount of the credit
The amount of the credit depends on the size of your business. Employers with 50 or fewer employees who received at least $5,000 in compensation may qualify for a credit equal to 100% of eligible startup costs, while those with 51 to 100 employees may qualify for 50%. In both cases, the annual credit is limited to the greater of $500 or $250 multiplied by the number of eligible NHCEs, up to a maximum of $5,000. You may also claim the credit for ordinary and necessary costs to set up and administer the plan and educate your employees about the plan.
Tax credit for plan contributions
Small employers may claim a tax credit for plan contributions made to a defined contribution plan, SEP, or SIMPLE IRA plan. The tax credit is not available for contributions to employees earning more than a certain amount. For employers with 1-50 employees, the tax credit available for each participant is:
- First plan year: 100% of contribution, up to $1,000
- Second plan year: 100% of contribution, up to $1,000
- Third plan year: 75% of contribution, up to $1,000
- Fourth plan year: 50% of contribution, up to $1,000
- Fifth plan year: 25% of contribution, up to $1,000
For employers with 51-100 employees, the tax credit available for each participant is:
- First plan year: 100% minus 2% for each employee exceeding 50 limit
- Second plan year: 100% minus 2% for each employee exceeding 50 limit
- Third plan year: 75% minus 2% for each employee exceeding 50 limit
- Fourth plan year: 50% minus 2% for each employee exceeding 50 limit
- Fifth plan year: 25% minus 2% for each employee exceeding 50 limit
No deduction allowed
You can’t both deduct the startup costs and claim the tax credit for the same expenses. You aren’t required to claim the allowable credit.
Military spouse employees
Small employers with 1-100 employees that have a defined contribution plan, SEP, or SIMPLE IRA plan that hire a military spouse may be eligible for a tax credit. The military spouse:
- Cannot be a highly compensated employee
- Must participate in the plan within two months of being hired
- Should be eligible for matching or nonelective employer contributions as if they were employed for two years, and
- Must be 100% vested in all contributions.
The amount of the tax credit an employer may claim is $200 for employing the military spouse, plus 100% of the contributions made, up to $300. The maximum tax credit is $500 and may be claimed for the first three years the military spouse participates in the plan.
Auto-enrollment tax credit
An eligible employer that adds an auto-enrollment feature to their plan can claim a tax credit of $500 per year for a 3-year taxable period beginning with the first taxable year the employer includes the auto-enrollment feature. This tax credit is available for new or existing plans that adopt an eligible auto-enrollment plan.
Final thoughts
Whether you’re considering offering a retirement plan for the first time or looking to enhance an existing plan, understanding the available tax credits can help you maximize the benefits for your business and employees. Eligibility requirements and credit amounts vary, making it important to evaluate your options carefully. SEK’s Business Tax & Advisory and Retirement Planning professionals can help you navigate these incentives and determine which opportunities may be available to your business. Contact us to learn more.
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