Secure Act 2.0 created some exciting new tax credits for small businesses related Employee Pension Plan costs. Although the terminology used in the legislation is “Pension Plan”, this credit applies to many types of business retirement plans including the Simplified Employee Pension (SEP plan), SIMPLE IRA, and 401k plan.
Many small business employers want to offer retirement plans to their team, but they worry about the cost associated with a retirement plan. This can be a downward spiral, because without good benefits you will struggle to attract quality employees and without quality employees, you will struggle to be profitable. Thankfully, new tax laws have been recently enacted to relieve this problem. By providing new credits to small businesses employers, the tax code is incentivizing the creation of new retirement plans and helping small employer compete in this tight labor market.
More Credit for Starting a Business Retirement Plan
Under the new law, credit for your pension plan startup costs has doubled, jumping from 50% to 100% of eligible expenses. This means that for some small business employers all the costs in the first year will be offset by the credit. This enhanced tax credit makes it an ideal time for small businesses to consider setting up pension plans, providing valuable retirement benefits to your employees.
Credit for Employer Retirement Plan Contributions
There’s now an extra incentive for businesses that contribute to their employees’ defined contribution pension plans. You can receive a credit for each employee you make a contribution for except for HCEs. The credit is capped at $1,000 per employee. This credit can cover up to 100% of your contributions during the first 2 years, making it an excellent way to enhance your employees’ retirement savings at reduced cost to your business. However, the credit may not cover all of the employer contribution. Since most employers will contribute 3% of more of wages to each employee’s retirement account, a typical contribution for an employee who makes $60,000 would be $1,800. In this case the credit will give you back $1,000, but the employer would still have an expense for the remaining $800 contributed.
The enhanced credit for employer contributions is available only for the first five years of the plan. The 100% credit rate decreases annually over four years to 75%, 50%, and then 25%. However, it is still possible to get up to $1,000 of credit per employee even after the first year. For example, if your employee makes $80,000 and you contribute 5% into their retirement, then your $4,000 contribution x 25% (in the 5th year) will still equal a $1,000 tax credit for that employee.
Which Retirement Contributions to Employees Will I Get Tax Credit For?
It’s important to know that contributions for employees earning over $100,000 annually aren’t eligible for the credit. They are included in the definition of Highly Compensated Employees (HCEs) who are excluded from this credit. Please note that the definition of HCE also includes business owners and their families. A business where family members are the only employees would not get credit for any employee contributions. When all employees are family members it may be better to use personal retirement accounts, and not make any retirement contributions through the business. If you have a situation like this, that is a good reason to get professional advice about what is best for your exact situation.
Rules for Larger Employers
Previously, the credit was limited to employers with up to 50 employees. Now, businesses employing between 51 and 100 people can also take advantage of this credit, although at a 50% rate. This expansion helps more small businesses offset the costs of starting pension plans. For businesses on the larger side of the small business spectrum (51-100 employees), these contribution credits are reduced by 2% for each employee over 50. For example, if you have 51 employees and would have qualified for $40,000 of tax credit, your actual credit will be reduced to $39,800 because of the extra employee.
How Do I Claim Tax Credit for a New Retirement Plan?
Both the start-up cost credit and the credit for employee contributions can be claimed on IRS Form 8881. By taking advantage of these additional credits and expanded eligibility, small businesses can more affordably offer pension benefits, improving employee satisfaction and retention. Now is an opportune time to assess your business’s capability to start or enhance a pension plan, leveraging these credits for financial advantage and contributing positively to your employees’ futures.