How 4 tax credits could cover 100% of your company's 401(k) plan costs for the first three years

If you’re a business owner looking for ways to attract new talent and improve retention, offering a retirement benefit like a 401(k) can be a great way to give your company a competitive advantage. Sounds great, right?

As good as it may sound, many companies still don’t offer a retirement plan, with many business owners citing cost as a barrier. In a recent survey, more than two-thirds of benefits decision-makers who don’t offer a retirement plan said they believe offering a 401(k) is cost-prohibitive.¹ While retirement benefits are often perceived as expensive to start and complicated to manage, that's no longer always the case.

To make these benefits more accessible, Congress established retirement plan tax credits under the SECURE Act, which took effect in 2019 and was later expanded and revised in 2022. SECURE 2.0 aims to make it easier for businesses like yours to provide affordable retirement plans and expand access to benefits. In fact, thanks to the SECURE Act and SECURE 2.0, eligible businesses may receive up to $16,500 in tax credits over a plan's first three years. These credits include:²

• Startup tax credit
• Automatic enrollment credit
• Employer contribution cost credit
• Military spouse credit

While these tax credits were established to increase 401(k) access, our research shows that many businesses don’t know about them — nearly 50% of benefits decision-makers are unaware of the retirement tax credits their companies may qualify for.³

If you’re uncertain which retirement tax credits are available for your business, you’re not alone. In this post, we’ll break down the four credits that you may be eligible for that can help you affordably offer a 401(k), and show you how to claim them for your business.

Is your business eligible?

First things first – these tax credits aren't automatic, and several factors will determine if you're eligible and how much you can claim. You should consult a tax professional to determine what types of tax credits or deductions your company is eligible to claim. But generally, your business may qualify if:

• Your business had 100 or fewer employees who earned at least $5,000 in the previous year.
• If you have yet to sponsor another retirement plan in the three tax years prior. (Note: This rule only applies to the startup tax credit and employer contribution cost credit)
• The plan will cover at least one non-highly compensated employee (NHCE), which for the 2024 tax year is generally anyone who did not own more than 5% of the company and did not earn more than $150,000 in 2023. (Note: This rule doesn't apply to the automatic enrollment credit.)

Now, let's review the tax credits your business may qualify for.

Startup tax credit

What it is:

If your business qualifies for the startup costs tax credit, you can claim a credit for your 401(k) startup costs for up to three years after establishing the plan, so long as you continue to qualify.

This credit equals a percentage of your qualified startup costs, including what the IRS calls "the ordinary and necessary costs" to set up and administer your plan. These costs can include record-keeping fees, payroll deduction software, printing costs for enrollment materials, and money spent educating your employees.

How it works:

You can claim the startup tax credit for the first 3 years of your company’s plan. Note, you’re able to begin claiming the credit the year before the tax year in which your plan becomes effective. When used, the credit will reduce your business' federal income tax liability on a dollar-for-dollar basis.

The amount of the credit may vary depending on the size of your business:

• For businesses with 50 or fewer employees, the credit covers 100% of administrative costs for the plan’s first three years.
• For businesses with 51 to 100 employees, the credit covers 50% of administrative costs for the plan’s first three years.

Credit amount:

The credit covers a maximum of $250 per eligible NHCE, but not more than $5,000 or less than $500 in any single year.

Automatic enrollment credit

What it is:

The automatic enrollment tax credit was established to encourage more employees to participate in their company-sponsored retirement plans. And as a business owner, you benefit from this tax credit simply by offering a qualified plan.

How it works:

If your business qualifies, you can choose one of two automatic enrollment arrangements:

• An eligible automatic enrollment arrangement (EACA), which automatically enrolls participants who fail to make a deferral election at a default deferral rate, or:
• A qualified automatic enrollment arrangement (QACA), which combines the automatic enrollment of an EACA with an automatic increase provision as well as a safe harbor provision.

Unlike the startup tax credit, your retirement plan doesn't need to be new to qualify — only the EACA or QACA feature needs to be new.

Credit amount:

If you're eligible and add auto-enrollment to your company's plan, you can claim a tax credit of $500 per year for three years, beginning with the first year you include auto-enrollment.

It's important to note that you must keep automatic enrollment active to continue to qualify for this credit. For example, if you stop auto-enrollment after two years, you'll only be eligible for the credit for those two years.

Employer contribution cost credit

What it is:

The employer contribution cost credit is a tax credit for the contributions you make to your employees’ retirement savings.

How it works:

The number of employees you have determines this credit’s value. For a business with 50 or fewer employees, the tax credit can be up to:

• 100% of contributions in the plan’s first 2 years;
• 75% in the third year;
• 50% in the fourth year, and;
• 25% in the fifth year.

If your company has 51 to 100 employees, your tax credit would be reduced by 2% for each employee over 50. For example, if your business has 62 employees in the first year, your percentage would be 100 - (12 x 2) or 76% of employer contributions.

Credit amount:

The maximum credit is up to $1,000 per eligible participant. However, the amount will vary depending on how many employees you have, how long you've offered the plan, and the actual contributions made to each employee.

Military spouse credit

What it is:

The military spouse credit encourages those employing spouses of active duty service members to allow them to participate in their retirement plan right away. Military spouses often change employment frequently, which may delay their retirement savings if they have to keep re-meeting service requirements. This credit was established to help those spouses save for their futures.

How it works:

If your business has 100 or fewer employees and employs a military spouse who is an NHCE, you can claim $200 per military spouse, as well as 100% of all employer contributions for the spouse, up to $300. This military spouse credit is available for three years per military spouse.

There are a few requirements to qualify for this credit, including but not limited to:

• The spouse must be eligible for your company’s plan no later than two months after starting employment.
• The spouse must be 100 percent vested immediately in all employer contributions and those contributions must be the same as made to other eligible participants.

For more details, check out the IRS’ military family tax benefits resource.

Credit amount:

The maximum credit is $500 per military spouse per year for three years.

Potential tax credit savings

As we’ve stated above, the tax credits your business can claim depend on several factors, but to help give you an idea of how much you could potentially save, let's look at an example.

Suppose your business employs 12 people, and they all participate in your company's newly established 401(k) plan. Three of your employees are highly compensated, and the other nine are NHCEs.

In this example, you offer a 401(k) with Guideline's Core plan, which costs $89 per month + $8 per participant. Your monthly costs amount to $185, or $2,220 annually.

(Note: In this example, we’ll assume that all employee information and pricing stays the same for the three years of tax credit eligibility.)

First, let’s look at the startup tax credit. If you qualify, the credit covers up to $250 per eligible NHCE, for a total credit of $2,220 ($250 x 9 NHCEs.)

Then, we have the automatic enrollment credit. All Guideline 401(k) plans include automatic enrollment without exception, which means you'll be eligible for an additional $500 tax credit each year for three years.

In this example, retirement tax credits would offset your total annual 401(k) costs completely. (Note: This doesn't include employer contributions, which may be 100% tax deductible.)

Estimate your costs

Use our tax calculator to estimate the costs of offering retirement benefits to your employees and uncover the potential tax credits you might be eligible for.

How do I claim retirement tax credits?

If you qualify for these tax credits, claim them on your organization’s tax filing using the IRS’ Form 8881, Credit for Small Employer Pension Plan Startup Costs. The IRS’ instructional guide provides in-depth guidance on how to complete this form.

Unlock tax credit savings for free with help from MainStreet

If you’re looking for support with preparing the paperwork to claim your tax credits, you’re in luck. MainStreet⁴ is offering Guideline's customers help with claiming their retirement tax credit services — for free.

How does it work? It’s simple.

1. MainStreet’s AI-enhanced system will scan 77,000 pages of tax code to identify the credits you’re eligible for.
2. Then, they’ll provide the paperwork for your businesses to include in your tax filing.
3. MainStreet will waive their service fees on any retirement plan related credit claims paperwork.

Whether it’s the first time you’re offering a 401(k) or your benefits program is a well-oiled machine, MainStreet can help you claim the tax credits your business deserves. Learn more today.

Disclosures:

This information is general in nature and is for informational purposes only. It shouldn’t be used as a substitute for specific tax, legal and/or financial advice that considers all relevant facts and circumstances. Investing involves risk and investments may lose value. Tax laws and regulations are complex and subject to change. You should consult a qualified financial adviser or tax professional before relying on this information.

¹ Source: Guideline research run with Suzy. Insights based on data collected February 2024, from a survey of 350 US-based employers who do not offer a retirement benefit. Guideline was not identified as the survey sponsor. The experiences of the respondents in this survey may not be representative of all people.

² This content is for informational purposes only and is not intended to be taken as tax advice. Please consult a tax professional for l to determine what types of tax credits or deductions your company is eligible to claim.

³ Source: Guideline research run with Suzy. Insights based on data collected February 2024, from a survey of 422 US-based employers who do not offer a retirement benefit. Guideline was not identified as the survey sponsor. The experiences of the respondents in this survey may not be representative of all people.

⁴ Guideline is not affiliated, associated, authorized, endorsed by, or compensated by the company listed, and their subsidiaries or its affiliates. Nor, does Guideline endorse or recommend any of the services or products marketed by this company. Please contact a financial, tax, and/or legal advisor to determine if any of these vendors or their applications and products are appropriate for your specific circumstance.