May 31, 2022

Retirement Plan Startup Costs and Small Employer Auto Enrollment

In December 2019, the Setting Every Community Up for Retirement Enhancement Act ("SECURE Act") was signed into law. This act allowed eligible employers to add an auto-enrollment feature to their plan and claim a tax credit of $500 for three years for the ordinary costs of starting a SEP, SIMPLE IRA or qualified plan.

Eligible employers must meet three requirements. These requirements include having fewer than 100 employees who were paid a minimum of $5,000 of compensation in a preceding year; employers must cover at least one non-highly compensated employee with the retirement plan; and finally, in the three preceding tax years before the first year of eligibility, employees were not substantially the same employees who received contributions or accrued benefits in another retirement plan sponsored by you as the employer, a member of a controlled group that includes you as the employer, or a predecessor of either.

Note that a highly compensated employee is an individual who owned more than 5% of the interest in the company at any time during the current or preceding tax year (regardless of the amount of compensation actually received) or for the preceding year, the individual received compensation from the business of more than $130,000 (if preceding year is 2021 and $135,000 for 2022), and was in the top 20% of employees when ranked by compensation.

A few things to keep in mind when determining whether the Start Up Tax Credit applies:

  • Adding a 401(k) feature to a profit-sharing plan does not qualify for the startup tax credit
  • To qualify for the $500 tax credit, the automatic enrollment feature must meet Eligible Automatic Contribution Arrangement (EACA) requirements.
  • Automatic enrollment adds two major administration responsibilities to a 401(k) plan:
  • Distributing an annual notice to eligible employees that explains the feature, including the employee’s right to make their own deferral election
  • Withholding wages from automatically enrolled participants at the plan’s default deferral rate
  • If the automatic enrollment feature includes an escalating default rate, the employer must also remember to increase the default deferral rate for automatically enrolled employees each year
  • You can’t both deduct the startup costs and claim the credit for the same expenses.
  • The SECURE Act raises the required minimum distribution age to 72 from 70½

In the most recent legislation, the SECURE ACT 2.0 will build on the original SECURE ACT passed in 2019. The updated bill will further improve retirement savings opportunities for employees. SECURE ACT 2.0 will aim to require employers to establish new defined contributions plans that would automatically enroll new employees when they become eligible for the benefit. Additional provisions of the updated act will create an online retirement savings database, create a tax credit of up to $1,000 per employee for small business, expand self-correction opportunities, increase public awareness of the credit, extend to 403(b) retirement plans, eliminate some barriers to offering lifetime income annuities, and will allow nonprofits to join together.

To conclude, the SECURE ACT and SECURE ACT 2.0 provide substantial tax savings for both employers and employees. These credits and tax savings are plentiful and easily applicable to many small businesses and employers across the United States.