By Sean Condon, CFP®
One of the best ways to attract top talent and support your employees’ financial wellness is to offer a company-sponsored 401(k).
For small companies funneling much of their revenues back into the company, 401k costs can be prohibitive. To comply with your fiduciary obligations of running a 401(k) plan, there are professional and investment costs that need to be paid.
Fortunately, the game is changing. Thanks to the new SECURE ACT 2.0, you may be able to set up a 401(k) this year… at no cost.
If you have been thinking about offering a 401(k) to your employees, here is a primer on the new rules and how it might benefit your firm.
SECURE ACT Tax Credits Can Pay For Starting A New 401(K) Plan
In the past, small businesses were offered $500/year in tax credits (for up to three years) to help cover 401(k) start-up costs. Starting in 2023, these credits are increased up to a maximum of $5,000 annually, for up to three years. Because many 401k plans can be implemented for less than $5,000, the new tax credit effectively makes it possible to launch a 401k plan for free.
The amount of the tax credit available depends on the number of employees in your company. The tax credit can be used to offset 100% of retirement plan costs (up to the $5,000 maximum) for companies with under fifty employees, and 50% of plan costs for companies with 51-100 employees. If you have less than 20 employees, the credit is limited to $250 per non-highly compensated employee (those with a salary of $150,000 or more). For example, if your small business had fifteen non-highly compensated employees, you would receive a credit of $3,750 (15 x $250) each year for up to three years.
To receive any tax credits, it is required that the plan covers at least one non-highly compensated employee. So unfortunately, an owner-only business is unable to take advantage of the startup tax credit by adopting a solo 401(k) plan.
Bonus Tax Credit For Setting Up Automatic Enrollment
The SECURE ACT not only offers you an incentive for opening a 401(k) but it also encourages your employees to participate as well. In addition to the credits, you receive for starting a new 401(k), you will receive an additional $500 credit if you adopt an automatic enrollment plan.
It is common for new employees to miss employer-sponsored retirement benefits because they do not enroll in the plan. With an automatic enrollment plan, they will be opted-in to your company’s 401(k) by default when hired. This behavioral tool can lead to real financial results for you and your co-workers; when enrollment is voluntary, only 28% of new employees enroll in their company retirement plan. However, when enrolled automatically, 91% of employees stay enrolled. 
It is important to note that this bonus tax credit is also available to companies who set up automatic enrollment on an already established 401(k). This is relevant because due to law changes in the SECURE Act most 401(k) plans must add the auto-enrollment feature by 2025. Small businesses may want to add the auto-enrollment feature now to minimize the potential disruption in 2025 as well as take advantage of this tax credit.
Costs To Offer An Employee Match Can Be Variable
A potential outlay related to launching a 401(k) is not just the costs of administering the plan but the dollars you give to employees via a match. A match is a great benefit for employee retention and the financial wellness of your team. Aiming for a match around 3% of your payroll is a laudable goal. In the scheme of your entire benefits cost structure, many would argue that this is a relatively small price for the long-term financial benefits you are providing your employees.
Understandably, not all small companies can initially afford to provide a 401(k) match. What many founders don’t realize is that the cash outlay for a match can be very flexible based on your company’s needs. For example, while matching contributions are a great benefit for employees, providing a match is entirely optional. Many small companies choose to start a plan without providing a match so that their team can at least begin to save on their own. This keeps plan costs to a minimum. Another technique is to provide just a small match – for example 0.25% of salary – with the goal of increasing it in the future. This can be affordable for most businesses while encouraging employees to begin the sound habit of saving for themselves as soon as they can.
New Tax Credits For Employer Contributions
For owners that do make employer contributions to their employees’ accounts, The SECURE Act created another tax credit to offset this expense. Employers with less than 50 employees may receive a $1,000 credit per employee (earning less than $100K) per year for employer contributions. The credit begins at 100% of contributions (up to the $1K max).
This means that in the first year of the plan, you earn a credit of $1,000 for every employee who received plan contributions of $1,000. The percentage is also 100% in the second year, then 75% in the third year, 50% in the fourth year, and 25% in the fifth year, and none for subsequent years. There are also contribution tax credits available for firms with 51-100 employees with additional phase outs over five years.
How Do I Apply For The Tax Credit?
You must file IRS Form 8881 (Credit for Small Employer Pension Plan Startup Costs) with your tax return to claim the startup tax credit.
With all the new tax credits available, now is the perfect time to finally set up your company’s 401(k). As with any new project, you should have a clear idea of how much cash flow will be needed to offer a 401(k) plan before launch. Your provider or investment advisor can show you the annual cost of funding a plan under different scenarios, including future staff growth, salary increases, or additional profit sharing.
To make the best decision for you, your employees, and your company, it is a good idea to consult with a financial advisor. If you have any questions, we at Windgate Wealth Management are happy to help. You can reach us by calling (844) 377-4963 or emailing firstname.lastname@example.org. You can also book an appointment online here.