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Case of the Week: Remember Plan Tax Credits for 2021

Case of the Week

The ERISA consultants at the Retirement Learning Center Resource regularly receive calls from financial advisors on a broad array of technical topics related to IRAs, qualified retirement plans and other types of retirement savings plans. We bring Case of the Week to you to highlight the most relevant topics affecting your business.

A recent call with a financial advisor from Arizona is representative of a common inquiry related to incentives for setting up retirement plans. The advisor asked:

“Can you remind me of the special tax credits available for small businesses that set up qualified retirement plans, please?”

Highlights of Discussion 

My pleasure! Small business owners (with fewer than 100 employees) are eligible for additional tax credits for setting-up retirement plans and/or adding an automatic enrollment feature. The credit is available if the owner establishes a 401(k), a SEP or a SIMPLE IRA plan. The business must: 

  • have had fewer than 100 employees who received at least $5,000 in compensation for the preceding year; 
  • have at least one plan participant who was a nonhighly compensated employee; and
  • not have maintained a plan in the past.

Eligible businesses may claim the credit using Form 8881, Credit for Small Employer Pension Plan Startup Costs.

The “Startup Credit” is up to $5,000 (a formula applies), available for the first three years the plan is in existence and offers real benefits to owners by freeing up tax dollars for other important business purposes. The credit was greatly improved as part of the Setting Every Community Up for Retirement Enhancement (SECURE) of 2019, effective Jan. 1, 2020 (increasing the maximum credit from $500 to $5,000). It is intended to encourage owners to establish retirement plans by helping make the plan more affordable during the startup process. In addition, the owners receive full tax deductions for all contributions made to the plan.  

On top of that, if an owner elects to add an automatic enrollment feature to the plan, an additional $500 credit (for the first three years) is also available. The automatic enrollment feature calls for newly eligible participants to be enrolled automatically in the plan with a specified default deferral rate. The IRS provides additional details about the startup and auto deferral credits here.

Conclusion

Tax credits for setting up a plan and having an automatic enrollment feature are great tools to help small businesses defray the costs of starting a plan. Business owners should discuss the credit with their accountants and advisors to determine if it makes sense for them to establish a plan. 

Any information provided is for informational purposes only. It cannot be used for the purposes of avoiding penalties and taxes. Consumers should consult with their tax advisor or attorney regarding their specific situation. 

©2022, Retirement Learning Center, LLC. Used with permission.

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All comments
Clark Armor
2 years 3 months ago
So, employees is defined as those with comp over $5000, whether it is a SIMPLE or a 401k? I have a restaurant group that started a 401k, with about 50 eligible, but about 150 employees who make over $5000. They thus would not qualify?