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New and enhanced tax credits for smaller employers can help make starting a retirement plan more affordable than ever.
SECURE 2.0 Act of 2022 created a substantial new startup tax credit to help small businesses establish retirement plans. This credit is based on contributions the employer makes on behalf of participants. SECURE 2.0 also expands the existing startup tax credit on employer plan costs. Together, these two credits may provide a significant benefit for small businesses that are starting a plan.
The contribution credit and cost credit are separate and distinct. Plans may receive one or both credits. To qualify for either, employers must:
For taxable years beginning after 2022, the new employer contribution tax credit is a decreasing percentage of the amount contributed by the employer for each employee earning no more than $100,000 per year, up to $1,000 annually per employee, over the plan’s first five years. This applies to defined contribution plans, such as 401(k), SEP and SIMPLE plans, that have no more than 100 employees.
The credit percentage for smaller plans — with 50 or fewer employees — phases down over five years from plan adoption, according to the following schedule. For plans with 51–100 employees, the percentage for the applicable year is reduced by 2% for each employee in excess of 50.
Phase-down schedule
Year 1 |
Year 2 |
Year 3 |
Year 4 |
Year 5 |
100% |
100% |
75% |
50% |
25% |
Note: The percentage is applied to the amount of employer contributions to determine the credit, which can be up to $1,000 per employee each year.
Note: All references to “employees” refer to those who received compensation of at least $5,000 in the preceding year.
Alpha Company’s contribution credit
In this hypothetical example, Alpha Company, a qualified employer, has 12 employees, 10 of whom make less than $100,000. Nine of the 10 participate in the retirement plan, and each contributes $3,000 a year. The employer’s match is 50%. Let’s calculate the contribution credit:
Beta Company’s contribution credit
In this hypothetical example, Beta Company is a qualified employer with 70 employees, 60 of whom make less than $100,000. Of those 60, 54 participate in the retirement plan, and each contributes $3,000 a year. The employer match is 50%. To calculate the contribution credit:
For taxable years beginning after 2022, the expanded credit reduces the amount of federal taxes that a small business may owe during each of the first three years of its first-ever retirement plan. Here are the basics:
In general, the credit amount may be limited for SEP and SIMPLE IRA plans because of their lower administrative costs. Share classes with fees used to help pay plan costs may also have limited benefits. Plans with fee-based financial professionals may pay more plan costs out of pocket, so the credit amount may be greater.
Note: All references to “employees” refer to those who received compensation of at least $5,000 in the preceding year.
Alpha Company’s cost credit
Let’s look at Alpha Company from the previous example, with 12 eligible employees, 10 of whom make less than $100,000. Alpha Company pays annual plan costs of $4,500. To calculate the plan cost credit:
If Alpha Company received both credits (the new employer contribution credit and the expanded plan cost credit), the tax credits for year 1 would total $11,500.
Beta Company’s cost credit
Beta Company, from the previous example, is a qualified employer with 70 employees, 60 of whom make less than $100,000. Beta Company pays annual plan costs of $6,000. To calculate the plan cost credit:
If Beta Company received both credits (the new employer contribution credit and the expanded plan cost credit), the tax credits for year 1 would total $35,400.
SECURE 2.0 requires certain plans starting after December 29, 2022, to use automatic enrollment. While the requirement is not effective until 2025, employers may consider including automatic enrollment at the time of launch to benefit from the following tax credit sooner:
The sooner you begin conversations about these new and expanded tax credits, the sooner employers can begin taking advantage and helping employees save for retirement.
Information as of Auguts 1, 2023. Other details, rules and exceptions may apply. This material does not constitute legal or tax advice. For more information, consult your financial professional, legal or tax advisor.
Examples are hypothetical and provided for illustrative purposes only; they are not intended to represent or predict actual results.
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