SECURE 2.0 tax credits provide incentive to offer retirement plan

Congress wants small employers to adopt retirement plans for their employees; however, small employers often cite cost as a barrier to adopting a plan. To address this issue, the SECURE 2.0 Act of 2022 (“SECURE 2.0”) made enhancements to the existing small employer startup credit and created a new small employer contribution credit. Let’s take a look at what that means for small businesses.

Enhanced startup credit

The startup credit is available to a small employer that establishes a defined contribution, defined benefit plan, a SEP, or a SIMPLE IRA. Features and considerations of the startup credit include the following:

• Employer eligibility. An employer is generally eligible for the startup credit if it meets all of the following requirements: 1) the employer has no more than 100 employees who received at least $5,000 of compensation; 2) the employer employs at least one non-highly compensated employee (“NHC”); and 3) the employer did not maintain a retirement plan in the preceding three years.
• Startup credit amount. An employer with 51-100 employees is eligible for a credit of 50% of eligible startup costs, while an employer with 50 or fewer employees is eligible for a credit of 100% of eligible startup costs. The credit is generally available for the first three years the plan is in operation. The credit amount is based on the number of NHCs eligible to participate in the plan. All eligible employers can receive at least an annual $500 credit, and the maximum annual credit is $5,000.
• Eligible startup costs. The startup credit is available for costs to set up and administer the plan, as well as costs to educate employees about the plan.

Employer contribution credit

SECURE 2.0 also added a new tax credit based on employer contributions (i.e., matching and/or nonelective contributions) made to a defined contribution plan, SEP, or a SIMPLE IRA. An eligible employer can receive both the startup credit and employer contribution credit. Highlights and considerations of the employer contribution credit follow:

• Employer eligibility. The eligible employer rules that apply to the startup credit also apply to the employer contribution credit.
• Employer size. For an employer with 50 or fewer employees, the credit available for each participant (other than participants who earn more than $100,000) is as follows, up to a maximum of $1,000 per participant:
  • First year: 100% of the employer contribution
  • Second year: 100% of the employer contribution
  • Third year: 75% of the employer contribution
  • Fourth year: 50% of the employer contribution
  • Fifth year: 25% of the employer contribution

Note that this credit is phased out at a lesser rate for employers with 51-100 employees.

Startup and employer tax credits in action

The example below illustrates how the startup and employer tax credits apply in the following situation.

Let’s say an employer has 30 employees. Two employees are highly compensated employees, and both earn more than $100,000. The remaining 28 employees are NHCs, all of whom earn less than $100,000. The employer, who did not maintain a plan in the preceding three years, adopts a 401(k) plan in 2024. The employer makes a matching contribution of 50% of deferrals up to 4% of compensation deferred. The matching contribution is capped at $1,000, and all participants defer enough compensation to receive a $1,000 match.

Startup credit. The employer has eligible startup costs of $2,000 in 2024, $2,500 in 2025, and $3,000 in 2026. Accordingly, the employer will receive a total $7,500 startup credit.

Employer contribution credit. The employer tax credit is determined as follows:

• 2024 – 28 eligible employees x $1,000 = $28,000 credit
• 2025 – 28 eligible employees x $1,000 = $28,000 credit
• 2026 – 28 eligible employees x $1,000 x 75% = $21,000 credit
• 2027 – 28 eligible employees x $1,000 x 50% = $14,000 credit
• 2028 – 28 eligible employees x $1,000 x 25% = $7,000 credit

The employer will receive a $98,000 employer contribution tax credit.

Total tax credit. The employer will receive $105,500 ($7,500 startup credits plus $98,000 employer contribution credits) in total tax credits from 2024-2028.

Also of note: Employer contributions may be deductible even if they are not eligible for the employer contribution credit.

If you have any questions about the tax credits discussed above, please contact your Union Bank & Trust Company relationship manager or a qualified tax advisor and we’ll be happy to help.