Now Is the Time to Start a 401(k)
The Setting Every Community Up for Retirement Enhancement Act ("SECURE" Act) was enacted in 2019 and introduced changes aimed at promoting retirement savings. One of the key provisions of the SECURE Act was the expansion of retirement plan access to part-time workers, but the Act also included many other provisions aimed at promoting retirement savings.
Recently, lawmakers in the United States have passed a follow-up to the SECURE Act called the SECURE Act 2.0. This legislation includes additional provisions aimed at promoting retirement savings, including the introduction of tax credits to encourage more small businesses to offer 401(k) plans to their employees.
The tax credits are designed to help offset some of the costs associated with starting a new 401(k) plan, which can include administrative and advisory costs, legal fees, and other expenses. Potentially worth up to as much as $5,000 annually for three years, this may cover a significant portion of the employer’s costs. Additionally, any costs beyond the credit amount that are covered by the employer are tax deductible. The credit is available for plans that are implemented after December 31, 2023.
What companies qualify for the tax credit?
- The employer must have no more than 100 eligible employees who received at least $5,000 of compensation from the employer in the preceding year.
- The plan must have at least one employee eligible to participate who is not a highly compensated employee (for 2023, generally an employee making less than $150,000).
- No Prior Plans: The employer did not maintain a 401(a) or 403(a) qualified plan, a SEP or a SIMPLE-IRA in the three immediately preceding taxable years that covered substantially the same employees.
What plan costs may the credits be used for and what are qualified costs?
- These would include the plan document, administration, recordkeeping fees, and employee education.
- It is also possible that qualified costs include investment advisory services regarding the plan’s investment line-up. If an advisor also provides education, then it is qualified.
- Qualified start-up costs are defined as ordinary and necessary expenses paid or incurred by the employer in establishing or administering the new plan or educating employees about the new plan.
Startup Tax Credits for Plans with 1-50 Employees
Under the legislation, small businesses with 50 or fewer employees that start a new 401(k), 403(b), SEP or SIMPLE IRA plan would be eligible for a $5,000 startup credit for up to three consecutive years. However, there are two different credits available for small plans: a credit for startups and a credit for contributions. These are explained below:
The startup credit has a minimum credit of $500 per year and a maximum of $5,000 for each of the first three years. The credit is calculated by taking $250 multiplied by the number of eligible non-highly compensated employees (NHCE). An NHCE is normally defined as an employee who makes less than $150,000. The bottom line is that if you employ twenty or more NHCE’s, then your company will max out the tax credit of $5,000 per year for three years. If you have ten employees, you will have $2,500 in tax credits.
Small businesses who establish a plan (defined benefit plans do not receive this credit) may also take advantage of a tax credit for employer contributions. However, this one is available for the first five years of the plan’s life. To determine the credit for contribution costs, the credit is only for contributions made for eligible employees who earn $100,000* or less in Social Security wages (FICA wages) in the taxable year in which the tax credit is claimed. The maximum credit is the lesser of:
(a) the employer contribution or
(b) $1,000 for each eligible employee earning $100,000 or less in FICA wages.
For employers with 50 or fewer eligible employees, the credit reduces over the five-year period as follows:
|Year Plan is Established
|1st Year after Plan is Established
|2nd Year after Plan is Established
|3rd Year after Plan is Established
|4th Year after Plan is Established
* This dollar amount will be adjusted for future cost of living increases.
Startup Tax Credits for Plans with 51-100 Employees
There are two differences from the above for companies looking to implement plans with between 51 and 100 eligible employees: the tax credit percentage is reduced to 50% and the tax credit for contributions reduces pro-ratably at the rate of 2% for each employee above 50 employees.
Plans above 100 employees are not eligible for any startup tax credits.
Separately, there is a movement at the state level to mandate retirement plans. Sixteen states have already passed some form of legislation and twelve of them are currently mandating businesses offer a retirement plan to employees. Over twenty-five states are considering the same. Those with mandatory plans include Maryland, California, New York, Oregon, Virginia, Maine, New Jersey, Illinois, Connecticut, Delaware, Rhode Island, and Colorado.
These state mandated plans can be restrictive and complex. Considering looming mandates, business owners may want to look at implementing a traditional plan through the private sector. Regardless of company size, 401(k) plans are available to all companies and have higher contribution levels and much more flexibility.
For plan sponsors, the available tax credits may offset plan expenses for the first few years. Secure Act 2.0 offers significant opportunities for companies to offer and expand the benefits of a retirement plan for their employees.
Looking to Start a Plan?
DISCLAIMER: This newsletter is intended to provide thought-provoking commentary. The information presented herein has been obtained from and is based upon sources and vendors deemed to be reliable, but may be incomplete. Parkside Financial Bank Trust does not itself endorse or guarantee, and assumes no liability for, the accuracy or reliability of any third party data or the financial information contained herein.
Parkside Financial Bank & Trust does not provide tax, legal, or accounting advice. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal, or accounting advice. You should consult your own tax, legal, and accounting advisors before engaging in any transaction. Investments are not insured by the FDIC or any government agency, provide no bank guarantee, are not a deposit and may lose value.