In the last few years, there have been a lot of substantive changes in the retirement area. The SECURE Act 2.0 significantly expanded eligibility requirements for plan participants and even introduced mandatory enrollment in certain retirement plans. Both big and small businesses are impacted by the new regulations.
In addition to expanded federal regulations, businesses located in California have their own set of retirement rules. Small businesses with as few as 1 to 4 employees will have to register with CalSavers by December 31, 2025 and enroll their employees.
With retirement plan enrollment mandates, associated costs can be burdensome. The good news is that they are to be mitigated by small business retirement plan credits which got enhanced under the SECURE Act 2.0 for years starting after December 31, 2022. There are two primary types of credits: start-up cost credit and employer-contribution credit.
The Small Business Retirement Plan Start-Up Credit applies to plan set-up, administration, and employee education and is available for up to three years from the year the plan was initially set up. This credit covers 100% of qualified start-up costs for employers with up to 50 employees, and 50% for those with 51–100 employees, but it is capped at the greater of (a) $500, or (b) the lesser of: $250 for each employee that is a non-highly compensated employee eligible to participate in the plan, or $5,000.
Additionally, SECURE Act 2.0 introduced a credit for employer contributions to small business pensions, covering up to $1,000 per employee for the first five years. The percentage of this credit starts at 100% for the first two years, then decreases to 75%, 50%, and 25% in years three through five, respectively. Employers with 51–100 employees face a phased reduction of this credit, while employers with more than 100 employees are ineligible.
For plans that adopt automatic enrollment, a separate credit of $500 per year for three years is available. This credit applies to both new plans and existing plans that add auto-enrollment features. Retirement credits are claimed on Form 8881. However, no double dipping is allowed: retirement plan start-up expenses and employer contributions are reduced by the amount claimed as credits.
Eligible employers must have had 100 or fewer employees earning at least $5,000 in the prior year, and the plan must include at least one non-highly compensated employee. No similar plan must have been in place for the same group of employees within the last three years.
Important: The credits are nonrefundable, but if not used in the year incurred, it can be carried forward.
Example: Small Business Setting Up a 401(k) Plan
Business Details:
Number of employees: 20 (all earning under $100,000).
Start-up costs for the plan: $8,000.
Employer contributions in Year 1: $1,000 per employee.
Plan start date: January 1, 2024.
1. Calculating the Start-Up Credit
Eligible for 100% of start-up costs, as the business has fewer than 50 employees.
The credit can be claimed for up to three years.
Maximum start-up cost credit in a year is the lesser of $5,000 or $250 per eligible employee.
Calculation: $250 × 20 employees = $5,000 (limit).
Therefore, the credit for Year 1 will be $5,000 (even though the start-up cost was $8,000).
In subsequent years, the business can continue to claim the start-up cost credit for additional administration costs, capped at $5,000/year.
2. Calculating the Credit for Employer Contributions
In Year 1, the business contributes $1,800 per employee to the 401(k) plan.
The credit for employer contributions is 100% in the first year, subject to a per-employee cap of $1,000.
Calculation: $1,000 × 20 employees = $20,000 total credit.
The business receives the credit of $1,000 for employer contributions in Year 1. The employer contribution deductible expense is to be reduced by $20,000 for which the credit is earned.
Total Credits in Year 1
Start-up credit: $5,000.
Employer contribution credit: $20,000.
Total credit in Year 1: $25,000.
Additional Years:
Year 2: The start-up cost credit remains $5,000, and the employer contribution credit remains 100% of contributions up to $1,000 per employee.
Year 3: The start-up cost credit is still $5,000, but the employer contribution credit drops to 75% of contributions, up to $1,000 per employee.
Year 4: Contribution credit is 50%, and in Year 5, it is 25%. No credit is available beyond Year 5.
Comments