8564 / What tax credit is available for small business retirement plan start-up costs?

Eligible small employers (under IRC Section 408(p)(2)(C)(1)) who provide an eligible auto-enrollment feature are eligible for an additional $500 per year credit (for the first three years the auto-enrollment feature is offered).

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Planning Point: The credit for auto-enrollment can be claimed even if a new auto-enrollment feature is added to an existing plan.

Planning Point: Starting with the 2025 tax year, the SECURE Act 2.0 will require employers that establish new 401(k) or 403(b) plans to auto-enroll employees in the savings plans. The minimum auto-enrollment contribution rate will range from 3% to 10%. Each year, the minimum contribution rate will then increase by 1% until the rate reaches 15%. Under the law, small business employers with 10 or fewer employees and new businesses will be exempt from the auto-enrollment requirement.

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A tax credit for qualified retirement plan start-up costs is available to small business owners. A small business employer is eligible if, during the preceding tax year, it employed 100 or fewer employees who received at least $5,000 in annual compensation from the employer (the same definition that generally applies for SIMPLE retirement plans).¹ The plan must be available to at least one employee who is a non-highly compensated employee (a highly compensated employee is one who owns 5 percent of the business or who has earned more than $155,000 in 2024).²

Importantly, the small business employer is only eligible for the credit if its employees were not able to participate in another retirement plan sponsored by the employer, a member of a controlled group or a predecessor of either within three years of establishing the new plan (essentially, this requirement ensures that the plan truly is a newly-established retirement plan).³

The credit is equal to 50 percent of the ordinary and necessary costs of starting up the retirement plan, including both the costs of setting up and administering the plan and costs related to educating employees about the plan, up to a maximum credit of $500 per year.⁴ The credit is available for three years, with the option of first claiming the credit in the year before the year in which the plan becomes effective.⁵

Beginning in 2023, the 50 percent limit was increased to 100 percent under the SECURE Act 2.0 for small employers with 50 or fewer employees. The law also creates an additional tax credit for a percentage of the employer's contributions made to employees with compensation that does not exceed $100,000 for the year. The additional credit cannot exceed $1,000 per employee and will phase out over a five-year period. The additional credit also phases out for employers with between 51 and 100 employees, and the credit is reduced by 2 percent for each employee that exceeds the 50-employee limit in the prior year.

Employers who join an existing multiple employer plan (MEP) will also now be eligible to receive the tax credit for small employers even if the MEP has been in existence for several years (this provision is effective retroactively, for 2020 and all later tax years).
If the entire value of the plan cannot be maximized in a single year, the small business employer has the option of carrying it back or forward to another tax year, so long as that tax year does not begin prior to January 1, 2002. To claim the credit, the taxpayer must file Form 8881 with the IRS.⁶