Offering your employees a 401(k) plan can send a powerful message and serve as a critical recruiting and retention tool. Setting up and maintaining a retirement plan may seem high, but a tax credit for small businesses can offset them. The credits are available for the first three years of a new plan’s existence.
Tax Deductions
In addition to helping employees save money on a tax-advantaged basis, 401(k) retirement plan services offer valuable deductions for business owners. Understanding the rules around deductible contributions and timing is essential for optimizing the benefit to your company. The money that employees put into a company-sponsored retirement plan comes out of their taxable income (in the case of traditional or Roth 401ks) or is not taxed at all (in the case of a profit-sharing plan). These benefits and other employer-provided perks make a 401k a highly desirable employee benefit and help your company attract top talent. If your company has fewer than 100 employees, you may be eligible for a small-business startup credit, which can cover up to $5,500 in annual expenses during the first three years of a new 401(k) plan. This incentive is designed to offset the startup costs of a plan, including administrative fees and investment expenses. To qualify, your business must not have had a qualified retirement plan in place for any of the preceding three years, and your current employees must not be “substantially” the same as those who received contributions or accrued benefits in that plan.
Tax Credits
While employees enjoy saving pre-tax dollars for retirement through a 401k plan, your business also benefits. The IRS offers deductions and credits to help offset some of the costs associated with establishing and administering a 401k plan for your company. Depending on your circumstances, you may be eligible for the small business retirement plan credit to cover up to 50% of startup expenses up to $5,000 per year for the first three years of your new retirement plan. To qualify, your company must sponsor a traditional 401(k), profit-sharing, or money purchase pension plan and have 100 or fewer employees who earned at least $5,000 in the previous year and are not highly compensated. The tax credit is designed to help offset the costs of setup, recordkeeping, and legal fees associated with your company’s new 401k plan. In addition, if your company’s 401k plan includes an automatic enrollment feature (required for most plans beginning in 2025), you can claim an additional $500 credit for the first three years of your auto-enrollment program.
You should consult a licensed tax professional to learn how these rules apply to your business and determine which retirement plan options are best for your company’s situation.
Matching Contributions
401(k) employer match contributions are a great way to attract employees and increase morale, as they’re tax deductible for your business. A common practice is to contribute an amount that matches an employee’s contribution, up to a certain percentage of their salary. Consider implementing an automatic enrollment feature if your business wants to offer a higher matching contribution. This can help your business pass nondiscrimination testing and may even result in your highly compensated employees (HCEs) contributing more than you would expect, based on IRS rules about how much HCEs can contribute annually without running into safe harbor limits. Some businesses also opt to contribute profit-sharing dollars to their employees’ 401(k) accounts, which are also tax deductible for the company. However, these dollars can have vesting schedules that encourage employees to stay with the company for several years before they can take their money. There is now a special $500-per-year small business credit for small businesses to offset startup costs for a new 401(k) plan. To see if you qualify, it’s best to consult a CPA who can guide your strategy and discuss other aspects of establishing the plan, such as fiduciary liability, discrimination testing, and Department of Labor regulations.
Taxes on Withdrawals
The IRS has a tax credit that can help pay for setup and administrative fees when you sponsor your first 401(k) plan. The credits are available to small businesses that do not have other retirement plans and meet certain requirements. Talk to a tax or financial professional about the best options for your business. You can choose from several types of 401(k) plans. The most common type of 401(k) is the traditional profit-sharing 401(k), which gives employers flexibility in making contributions. For example, you can make them outright or contingent on how much employees defer, and they can be made with or without a vesting schedule. Withdrawals from a 401(k) are taxed at ordinary income rates. Employees can borrow money from their accounts, provided the employer allows it and has set terms. If you have to withdraw funds for unreimbursed medical expenses or the death of a loved one, there’s a 10% penalty. Investing in your team is one of the most important things you can do for your company. That’s why survey after survey shows that 401k plans are among the most popular benefits that employees want their companies to offer. Fortunately, payroll integration can help reduce the cost of 401(k) administration and compliance monitoring.
