Regulation & Legislation

A closer look at SECURE 2.0 startup tax credits

KEY TAKEAWAYS

  • SECURE 2.0 added an employer contribution startup tax credit.
  • The existing plan cost startup tax credit was expanded with SECURE 2.0.
  • Automatic enrollment will be required beginning in 2025.

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:
 

  • Have no more than 100 employees who received compensation of $5,000 or more in the preceding year
  • Not have offered a plan covering substantially the same employees during the previous three tax years

NEW: Employer contribution credit

 

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. 

Two examples of the contribution credit in action

 

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:
 

  • Employer contributions: 50% × $3,000 employee contributions = $1,500 for each of nine employees, but cap of $1,000 per employee is used to calculate the credit (see below)
  • Credit calculation: 100% × $1,000 = $1,000 for each of nine employees
  • The total year 1 tax credit is $9,000, based on $13,500 of total employer contributions for nine employees

 

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:
 

  • Employer contributions: 50% × $3,000 employee contributions = $1,500 for each of 54 employees, but cap of $1,000 per employee is used to calculate the credit (see below)
  • Credit calculation: 60% (100% – (2% × 20 employees in excess of 50)) × $1,000 = $600 for each of 54 employees
  • The total year 1 tax credit is $32,400, based on $81,000 of total employer contributions for 54 employees

EXPANDED: Plan cost 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:
 

  • For 50 or fewer employees, the credit covers 100% of the employer’s ordinary and necessary out-of-pocket plan costs, up to an annual limit. (This amount was previously 50%.)
  • For 51 to 100 employees, that same coverage is 50%.  
  • Covered costs are those paid by the employer to set up and administer the plan, such as financial professional and third-party administrator (TPA) compensation, recordkeeping fees and employee education expenses. The credit does not apply to plan costs paid through plan assets or investment expenses.
  • The annual limit is $500 or, if greater, $250 multiplied by the number of plan-eligible non-highly compensated employees (NHCEs), up to $5,000.
  • To qualify, a plan must have at least one participant who is a NHCE.

 

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.

Two examples of the plan cost credit in action

 

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:
 

  • Credit calculation: $4,500 plan costs × 100% (fewer than 50 employees) = $4,500
  • Maximum credit: 10 NHCEs × $250= $2,500
  • The total year 1 tax credit is $2,500 based on the maximum credit formula

 

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:
 

  • Credit calculation: $6,000 plan costs × 50% (more than 50 employees) = $3,000
  • Maximum credit: 60 NHCEs × $250= $15,000, but capped at $5,000
  • The total year 1 tax credit is $3,000, 50% of employer plan costs

 

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.

NEWLY REQUIRED: Automatic enrollment (starting 2025)

 

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:
 

  • Employers can earn a tax credit for adding or, in the case of a startup plan, including an automatic enrollment feature as part of their plan. The credit is $500 per year for the first three years the feature is included.
  • The credit is only available to employers who had no more than 100 employees with at least $5,000 in compensation in the preceding year.
  • To qualify, the feature must be structured as an eligible automatic contribution arrangement (EACA), following specific notice requirements, and uniformly apply the plan’s default contribution rate.

 

Start talking to employers today

 

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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