For many business owners, starting a 401(k) plan is both expensive and an administrative challenge. 401(k) plans can be a great benefit to your employees, but is it worth it for you and your business?
With the passage of the SECURE Act earlier this year, at least the costs have become easier to stomach. Congress greatly expanded tax credits available for starting a 401(k), 403(b), SEP IRA, or SIMPLE IRA. (If you want to know which of these is a good option for your business, see my piece here.) If you own a small business, you may be able to score tax credits to offset up to 50% of your 401(k) plan fees for its first three years.
Is Your Business Eligible?
Small businesses are eligible for this credit if:
- You have less than 100 employees.
- Your retirement plan will have at least one eligible “nonhighly compensated employee” (NCHE).
- You have not operated a similar retirement plan in the prior three years.
What Is an NCHE?
An NCHE is an employee who earned less than $125,000 in 2019 and does not own more than 5% of the business. For example, if you made $100,000 in 2019 but owned 10% of the business, you would be considered a “highly compensated employee” (HCE). Your participation in the plan could not be used to qualify for the credit, nor would you count toward determining the value of the credit.
How Much Is the Tax Credit Worth?
Your tax credit has a minimum value of $500 and a maximum value of $5,000. Since the credit is available every year for the first three years of your retirement plan, you could receive a tax credit worth up to $15,000!
To calculate your credit, you would:
- Count your eligible NHCEs.
- Multiply that number by $250 (up to $5,000 annually).
- Reduce the credit if needed to no more than 50% of your plan’s total annual operating expenses.
So, for example, if your plan costs $8,000 to operate annually, your credit could be limited to $4,000, even if you have enough NHCEs to qualify for the full $5,000 credit.
Starting a 401(k) plan is a difficult decision for a business owner. Hopefully this new credit helps, but it’s still advisable to explore all your retirement plan options before you pick one. Let us know if we can help you find a solution that works for your business.
Disclaimer: This material has been prepared for informational purposes only and should not be used as investment, tax, legal or accounting advice. All investing involves risk. Past performance is no guarantee of future results. Diversification does not ensure a profit or guarantee against a loss. You should consult your own tax, legal and accounting advisors.
