Tax credits can be a strong hand-up for small businesses. They’re the backbone of our economy, working hard, driving innovation, and providing jobs. But when it comes to setting up retirement plans, they’re hitting a wall of costs and red tape. But there’s good news! There is relief with the Secure 2.0 Act. It’s a real game-changer. It’s throwing in incentives and tax breaks, giving our small businesses the shot in the arm they need. This article will give you information on the Secure 2.0 Act. Plus, it will show small businesses the benefits of these tax breaks and supercharge their employees’ savings.
FYI, The SECURE 2.0 Act is a new law that aims to improve retirement savings options for Americans. It has nearly 100 provisions that cover various aspects of retirement savings.
As a bonus, we will look at a real-to-life case study of Lone Star Machining and how the Secure Act 2.0 helped them get their 401(k) started.
The Need for Retirement Plan Incentives for Small Businesses
According to research conducted by the AARP Public Policy Institute, about 78 percent of those who work in firms with fewer than ten employees and about 65 percent who work in companies with ten to twenty-four employees need a plan (John et al., 2022). The lack of availability can significantly affect employee financial security in retirement. However, a Capital Group survey indicates that the landscape is changing. “Over two-thirds of small business owners (73%) without a plan said they were ‘highly likely’ to offer one in the next two years” (Capital Group, 2023). The introduction of Secure 2.0 aims to further accelerate this trend by providing attractive tax breaks and incentives.
Tax Credits to Offset Plan Setup Costs
A significant barrier for small businesses when establishing a retirement plan is the associated administrative costs. To address this concern, Secure 2.0 offers a critical tax credit to offset the setup costs of qualified retirement plans. Previously, businesses with one to fifty employees could claim a tax credit covering 50% of eligible start-up costs. Those costs include administrative fees, consulting fees, or expenses associated with establishing the plan. However, under Secure 2.0, this coverage has been increased to 100% of the charges, with a cap of $5,000 per year for three years. This enhanced tax credit can significantly reduce the financial burden on small businesses. The Secure 2.0 Act makes it more feasible for them to implement retirement plans.
Employer Contributions and Tax Advantages
In addition to the tax credit for plan setup costs, Secure 2.0 introduces a new tax credit for employer contributions to defined contribution plans. Defined contribution plans are plans like 401(k) plans that have a specified limit for contributions. The new tax credit encourages small businesses to contribute to their employees’ retirement savings. The amount of the credit depends on factors such as the number of eligible employees and the number of years since the plan began. Small businesses with 50 or fewer employees can receive a credit of up to $1,000 per year for each employee earning less than $100,000. The credit gradually reduces by 25% each year starting from the third year.
Small businesses need to consult with their tax preparer to understand how deductions for employer contributions will be affected. By taking advantage of this tax credit, small businesses can not only boost employee savings but also benefit from tax advantages.
Auto-Enrollment Credit for Small Businesses
Automatic enrollment is a feature that can significantly increase employee participation in retirement plans. Small businesses can implement this feature now and qualify for a $500 tax credit for the first three years, even though it is not a requirement until 2025. While the added costs associated with auto-enrollment may concern small businesses, the tax credit can help offset these expenses. Small businesses should carefully evaluate the potential benefits of auto-enrollment and consider the long-term advantages of increased employee participation in retirement savings.
Starter 401(k) Plans: An Option for Small Businesses
Secure 2.0 introduces the concept of starter 401(k) plans, which allow small businesses to take advantage of applicable administrative tax credits without making contributions on behalf of their employees. This option is especially beneficial for small businesses that need help to afford to offer an employer match. With a starter 401(k) plan, small businesses can still provide their employees with a valuable retirement savings vehicle. The starter 401(k) plan can be a powerful recruiting tool and help employees prepare for their future financial security.
Focus on Tax Credits for Military Families
Secure 2.0 recognizes the unique challenges military spouses face in saving for retirement. To address this, eligible employers can claim a credit of up to $500 per military spouse participating in the company’s defined contribution plan, subject to certain conditions. Military spouses must be immediately eligible to participate in the program within two months of hire, and they must also become eligible for any matching or non-elective contributions within two years of service. This credit applies for three years and does not apply to highly compensated employees. It is helpful to know what highly compensated employees for 2023 are defined as
- Those who have received more than $130,000 in compensation during the preceding year (2022).
- Was a 5% business owner at any time during the year or the preceding year.
- Was a 1% business owner at any time during the year and received compensation from a company above $150,000.
By offering this credit, Secure 2.0 aims to support military families in building their retirement savings.
Roth IRA Options for Small Businesses
Secure 2.0 also allows small business owners to offer Roth versions within SEP IRAs and SIMPLE IRAs. Here is a brief overview of these types of plans in case you are still getting familiar with them.
- Roth IRA – A Roth Individual Retirement Account (IRA) allows you to contribute after-tax income, and qualified withdrawals, including earnings, are tax-free in retirement. It is a powerful tool for tax-free growth.
- SEP IRA (Simplified Employee Pension IRA) – A SEP IRA is a retirement plan tailored for self-employed individuals and small business owners. It enables tax-deductible employer contributions and offers higher contribution limits than traditional IRAs.
- SIMPLE IRA (Savings Incentive Match Plan for Employees IRA) – A SIMPLE IRA is a retirement plan commonly used by small businesses. Both employers and employees can make contributions. Employers must make either a matching or non-elective contribution. It is designed for easy administration and provides a retirement savings option for employees.
These plans have fewer administrative responsibilities than traditional 401(k) plans, making them popular for small businesses. Offering a Roth option within these plans can benefit business owners directly. Still, it can also be an attractive feature for recruiting and retaining talented employees. The Roth IRA option provides tax-free growth and tax-free withdrawals in retirement, making it a valuable tool for long-term retirement savings.
Retirement Plan Catch-up Provisions for Individuals
Secure 2.0 not only introduces benefits for small businesses but also offers opportunities for individuals to boost their retirement savings. One such benefit is catch-up provisions, which increase the ability to contribute more money to retirement after the age of 50. In 2023, the catch-up contribution limit is $7,500, compared to $6,500 in 2022. The Secure 2.0 Act further increases the catch-up contribution limit for participants between the ages of 60 and 63 starting in 2025. These enhanced contribution limits provide individuals with additional opportunities to accelerate their retirement savings.
Another significant change introduced by Secure 2.0 is the increase in the age at which individuals must start taking required minimum distributions (RMDs) from their traditional 401(k) or traditional IRA. The RMD is the minimum amount individuals must withdraw from their retirement accounts each year, typically starting at a certain age. The age requirement for Required Minimum Distributions (RMDs) will increase to age 73 in 2023. Additionally, beginning in 2024, there will be no RMD requirement for Roth 401(k) and Roth 403(b) plans, aligning them with Roth IRAs. These changes offer individuals more flexibility in managing their retirement savings and ensure they can maximize their investment strategies.
Cash Study of Lone Star Machining
Lone Star Machining is a small machine shop in Texas that has 40 employees and $6 million in annual revenue. Starting January 2023, the company now offers its employees a 401(k) plan. The plan will have the following features:
- A dollar-for-dollar match of the first 3% of salary for each employee
- Automatic enrollment for all eligible employees, with an opt-out option
- A vesting schedule of 100% after three years of service
- A diversified menu of investment options, including target date funds
- A third-party administrator that charges $2,500 per year for plan administration, paid quarterly
The company hired a consultant for $500 to set up the plan and provide ongoing advice. The company also took advantage of the tax credits available under the SECURE 2.0 Act, which aims to encourage small businesses to offer retirement plans.
Benefits of the 401(k) Plan
The 401(k) plan provides several benefits to both the company and its employees, such as:
- Increased employee retention and satisfaction: The 401(k) plan helps the company attract and retain qualified workers, as well as improve employee morale and loyalty. According to a survey by Transamerica, 75% of workers say that retirement benefits are a critical factor in their decision to stay with an employer (Collinson et al., 2022).
- Enhanced retirement savings: The 401(k) plan allows employees to save for retirement on a tax-deferred basis, with the added benefit of employer matching contributions. Assuming an average salary of $50,000, an annual contribution rate of 6%, and an annual return of 7%, an employee who participates in the plan for 30 years could accumulate over $900,000 in retirement savings(IRS, 2023). Note this is a hypothetical example. The past performance of investments is no guarantee of future results.
- Reduced tax liability: The 401(k) plan reduces the taxable income of the company and its employees, resulting in lower tax bills. The company can deduct matching contributions and administrative expenses from its taxable income. At the same time, the employees can defer taxes on their contributions and earnings until withdrawal. Assuming a 21% corporate tax rate and a 22% marginal income tax rate for the employees, the company could save over $30,000 in yearly taxes. In addition, the employees could save over $50,000 in yearly taxes. Please consult with your tax professional for specific tax guidance.
Tax Credits under the SECURE 2.0 Act
The SECURE 2.0 Act offers two types of tax credits to small businesses that start a new retirement plan:
- A credit for start-up costs: This credit covers up to 100% of the eligible costs of setting up and administering the plan, such as legal fees, consulting fees, and education expenses. The credit is based on the greater of $500 or $250 per non-highly compensated employee (NHCE), up to a maximum of $5,000 per year for three years. A NHCE is an employee who earned less than $135,000 in the previous year. In this case, since all 40 employees are NHCEs, the company can claim the maximum credit of $5,000 per year for three years, totaling $15,000.
- A credit for employer contributions: This credit covers a percentage of the employer matching or profit-sharing contributions made to the plan, up to $1,000 per NHCE per year for five years. The percentage varies depending on the number of employees and decreases over time. In this case, since the company has 40 employees, it can claim a credit of 100% for the first two years, 75% for the third year, 50% for the fourth year, and 25% for the fifth year. Assuming an average salary of $50,000 and a matching contribution of 3%, the company can claim a credit of $60,000 for the first two years ($1,000 x 40 x 2), $45,000 for the third year ($750 x 40), $30,000 for the fourth year ($500 x 40), and $15,000 for the fifth year ($250 x 40), totaling $195,000.
The Bottom Line
The total tax credits that the company can claim under the SECURE 2.0 Act amount to $210,000 over five years ($15,000 x 3 + $195,000). The tax benefits significantly offset the costs of offering the 401(k) plan. Plus, it can increase the net cash flow of the company. But please remember that this is an example to help educate you on the benefits possible. You should consult with your tax advisor for specific tax information related to your company.
Secure 2.0 brings new tax credits and incentives to help small businesses create retirement plans for their employees. By taking advantage of these benefits, small businesses can overcome cost concerns and administrative complexities. Ultimately, employees will boost their savings and financial security in retirement. Whether it is the tax credits for plan setup costs, employer contributions, auto-enrollment, Pooled Employer Plans (PEPs), or the introduction of starter 401(k) plans, Secure 2.0 offers a range of options for small businesses to consider. However, don’t go it alone. Small business owners must consult with tax advisors or financial professionals to about the specifics of the Secure 2.0 Act. New incentives empower small businesses to aid employees in securing their financial future.
Disclaimer: This information is for educational and informational purposes only and is not financial or legal advice. Please consult with a qualified professional for personalized recommendations tailored to your specific circumstances.
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Capital Group. (2023, May 4). Small business owners offering employee retirement plans are more attuned to employee needs during uncertain time. PR Newswire. https://www.prnewswire.com/news-releases/small-business-owners-offering-employee-retirement-plans-are-more-attuned-to-employee-needs-during-uncertain-time-301815328.html
Collinson, C., Rowey, P., & Cho, H. (2022, June). The retirement outlook of the workforce. Transamerica Center for Retirement Studies. https://transamericainstitute.org/docs/default-source/research/emerging-from-the-covid-19-pandemic-the-retirement-outlook-of-the-workforce.pdf
Internal Revenue Service. (2023, July 28). Retirement plans start-up costs tax credit. https://www.irs.gov/retirement-plans/retirement-plans-startup-costs-tax-credit
John, D., Koenig, G., & Malta, M. (2022, July 11). Payroll deduction retirement programs build economic security. AARP Public Policy Institute. https://doi.org/10.26419/ppi.00164.001