A qualified retirement plan is an important employee benefit to attract and retain valued workers. According to Vestwell 2023 Retirement Trends Report, 73% of employees agreed or strongly agreed they expect employers to offer a 401(k) plan. Yet BLS data say less than half (48%) of small employers offer a plan.
If you don’t have a qualified retirement plan, now may be a great time to consider it in light of tax incentives you can receive. If you already have a plan, now’s the time to review it and consider changes so you can take advantage of tax incentives.
These incentives are tax credits and they are limited to small employers. They can significantly cut your tax bill while you provide a retirement savings option for your staff. As a result of SECURE Act 2.0, which became law at the end of 2022, some of the tax credits are new or expanded for 2023. And, as you’ll see, having a single retirement plan can generate all 5 tax credits for you.
What’s a small employer?
Each of the 5 credits requires a business to be a small employer to qualify for a credit. This means having no more than 100 employees during the tax year preceding the first credit year who received at least $5,000 of compensation during the year. Each credit has its additional conditions, which you’ll see.
1. Start-up credit
This credit is designed to incentivize a business to start a qualified retirement plan. It’s technically called the pension plan start-up credit, but it isn’t limited to pensions (defined benefit plans); it applies to defined contribution plans as well (401(k)s, SEPs, SIMPLE-IRAs). The credit applies to the administrative costs for the plan as well as for educating employees about participation in the plan. The amount of the credit depends on the number of employees:
- If there are 50 or fewer employees, then the credit is 100% of costs.
- If there are 51 to 100 employees, the credit is 50% of costs.
The credit is capped at the greater of (1) $500 or (2) the lesser of (a) $250 per employee eligible to participate who is not highly compensated or (b) $5,000.
The credit applies for the first 3 years of the plan. But you can opt to take the credit in the year prior to the plan’s commencement. For instance, if you incur eligible costs this year for a plan that starts January 1, 2024, you can opt to take the credit on your 2023 return.
Additional conditions
There are 2 additional conditions:
- You can’t have had a qualified retirement plan for your business in any of the 3 preceding years.
- The plan must cover at least one employee who is not “highly compensated” (an owner or employee paid more than $150,000 in 2023).
More details. See the instructions to Form 8881, Credit for Small Employer Pension Plan Startup Costs, which contain basic rules but don’t reflect the 2023 changes.
2. Auto-enrollment credit
If you have a plan or start one and include an automatic enrollment feature, you can take a tax credit of $500 per year for up to 3 years. This credit is claimed in addition to the startup credit.
An automatic enrollment feature, for purposes of the credit, requires an employer automatically deducts elective deferrals from an employee’s wages as the employee’s contribution to a 401(k) or SIMPLE-IRA plan (there’s a schedule for the percentage of compensation used for this purpose). The employee is allowed to make an election not to contribute or to contribute a different amount.
More details. See the instructions to Form 8881, Credit for Small Employer Pension Plan Startup Costs.
3. Contribution credit
Contributions by an employer to a qualified retirement plan are deductible. Beginning in 2023, contributions by small employers can generate a tax credit. The credit is up to $1,000 per employee. The credit phases down over a period of 5 years. What’s more there is a further reduction for employers with 51 to 100 employees. In other words, the top credit goes to businesses with no more than 50 employees.
Additional conditions
The credit applies only for contributions on behalf of employees earning $100,000 or less in 2023, The credit is limited to employer matching or profit-sharing plan contributions. To the extent a credit is claimed, no deduction is allowed.
4. Military spouse coverage credit
If you have an employee who is a military spouse and offer enrollment to this employee in your defined contribution plan within 2 months of the start of employment, you can take a tax credit of $200. A military spouse is someone married to a member of the uniformed services who is serves on active duty. The military spouse cannot be a highly-compensated employee (again, an owner or employee earning more than $150,000 in 2023).
Additional conditions
The military spouse must receive the same employer contributions as other employees with 2 years of service. The military spouse must certify that his or her spouse is a service member and provide the spouse’s name, rank, and service branch.
5. Military spouse contribution credit
If you employ a military spouse and meet the conditions above, you may also claim a tax credit if you contribute to the plan on this employee’s behalf. Employee elective deferrals aren’t treated as employer contributions. The credit is 100% of employer contributions up to a maximum of $300.
Additional conditions
All employer contributions on behalf of a military spouse must be 100% immediately vested.
Final thought
Walt Disney said: “The way to get started is to quit talking and begin doing.”
Meet with your tax adviser to review your retirement plan options—what you have now or what you could have in the future. See how these options square with tax incentives and how you can cut your tax bill while doing a good thing in offering a retirement plan to your employees. Revise your budget accordingly.
Read more about retirement plans for you and/or your employees in a few earlier blogs.
