The SECURE Act in 2019 and SECURE Act 2.0 in 2022 expanded tax credits for smaller businesses that are newly offering retirement plans to their employees. If your company hasn’t previously offered a retirement plan or didn’t within the prior three tax years, you may be eligible to offset most or all of the out-of-pocket expenses of starting and operating a plan for the first few years, as well as offset employer contributions to certain employees. Our goal is to help you understand the credits you might be eligible to claim when you start and fund a plan—and how to actually claim those credits when due.
Let’s explore three key credits:
Automatic enrollment credit
Employer contribution credits
Startup cost credits
Automatic enrollment credit - $500 (three years)
Automatic enrollment—required for most plans started in 2023 and later—is a feature that pre-selects how much an employee will save from their paycheck towards their 401(k) plan. Employees can make a different election by choosing a different level of contributions, opting for Roth treatment instead of pre-tax, or deciding not to save at all. This ‘negative election’ feature greatly boosts the rate of employees who begin saving for retirement because it helps them overcome inertia while still giving them full control over their choices.
For the first three years that you offer automatic enrollment in your plan, you can claim an annual tax credit of $500 for your business. This credit aims to encourage the use of automatic enrollment—even for businesses not yet required to implement it—and to offset the initial costs of setting up this feature.
Summary:
Year 1 of offering auto enrollment: $500
Year 2 of offering auto enrollment: $500
Year 3 of offering auto enrollment: $500
Employer contribution credits - up to $1,000 per employee (five years)
In the first five years of offering a qualified plan, your business can claim a tax credit of up to $1,000 per employee to whom you made employer contributions (including safe harbor contributions, employer matching, and profit sharing deposits). These credits only apply to employees earning less than $100,000 in FICA wages for the year and are based on the amount of the employer contribution provided to those employees, up to $1,000 each.
The credit availability is automatically reduced starting in Year 3. It’s also reduced when the total number of employees in the prior tax year exceeds 50, specifically a 2% reduction for each employee in excess of 50 employees during the prior year.
Summary:
Calculate the actual employer contributions for the year, up to $1,000 each, for employees who earned under $100,000 in FICA wages (generally Box 3 on an employee’s W-2)
Apply the relevant year’s proportion:
Year 1: 100%
Year 2: 100%
Year 3: 75%
Year 4: 50%
Year 5: 25%
Reduce by 2% multiplied by the number of employees over 50 in the prior year
Startup costs - up to $5,000 (three years)
For the first three years of a qualified plan, your business can recoup up to $5,000 of out-of-pocket expenses related to setting up, administering, and educating your employees about the plan.
The dollar limit is based on how many non-owner, non-highly paid employees are eligible to participate in the plan. If it’s just one or two, the limit is $500; if it’s 20 or more, the limit is $5,000; and for anything in between, it’s $250 for each eligible employee.
Keep in mind that you can claim credits for the first year of the plan or the prior tax year if you paid eligible costs during that time. For example, if you paid initial setup fees in 2024 for a plan effective January 1, 2025, you could claim credits for the 2024 tax year.
Summary:
Determine the business’s total expenses paid for plan establishment, administration, and education—excluding any amounts paid from plan assets
Choose the greater of:
$500, or
The number of non-owner, non-highly compensated employees (we can help verify this count) multiplied by $250, up to $5,000
Reduce this amount by 50% if you employed 51–100 employees during the tax year for which you are claiming the credit
Claiming credits
Businesses work with their tax preparer to file Form 8881 (or Form 3800, if applicable) for each tax year that these credits may be claimed. When you work with Aboon, we’ll prepare a summary of information required by your tax preparer, including any necessary calculations, to finalize the Form and timely claim these credits.
These credits are generally limited to businesses with no more than 100 employees earning $5,000 or more in the year before establishing the plan. In other words, these credits are generally limited to employers who are eligible to establish a SIMPLE plan and haven’t maintained another plan in the prior three years.
It’s important to note that any expenses, including employer contributions, for which you claim a credit cannot also be treated as a deduction. The key difference is that a credit is more like a direct rebate rather than a reduction in taxable income.