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January 4, 2024

Understanding start-up tax credits under SECURE Act 2.0

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The SECURE 2.0 Act, ushering in its first anniversary, has notably revamped start-up tax credits for employers initiating new retirement plans. Eligibility criteria and credit calculations have significantly changed the landscape for small and medium-sized businesses. To grasp the intricacies of this evolution, let's delve into the eligibility requirements, the determination of credits, and the crucial details employers must consider.

Eligibility hinges on whether the employer maintained another qualified plan. This includes a SEP or a SIMPLE for substantially the same employees in the three-taxable-year period preceding the first taxable year for which the credit would be available. Additionally, the start-up plan must cover at least one non-highly compensated employee.

Determining the amount of credits involves navigating through the provisions of SECURE 2.0 Act. While the original SECURE 1.0 Act offered a 50% credit of administrative costs for eligible employers, the updated SECURE 2.0 Act has expanded these benefits. Employers with up to 50 employees now enjoy a 100% credit, while those with 50 but no more than 100 employees retain the original 50% credit. 

Moreover, an additional credit based on employer contributions has been introduced. This credit is calculated by applying an "applicable percentage" to the employer's contributions on behalf of employees, up to a per-employee cap of $1,000. However, this full additional credit is limited to employers with 50 or fewer employees, with reductions for those with 51 to 100 employees over a five-year period.

Understanding the evolving percentages over the initial five plan years is crucial, ranging from 100% in the first and second years to 25% in the fifth year, with no credits thereafter. Employers with 51 to 100 employees face a reduction in these percentages for each employee exceeding the 50-employee limit.

Employer contributions to an employee's retirement account are eligible for the credit calculation if employee wages for the taxable year are less than $100,000, indexed annually for the cost of living. The employer aggregation test determines eligibility, emphasizing that all businesses under common control must be aggregated in determining employee count.

Plan sponsors must choose between a deduction and a tax credit for start-up costs, which can significantly impact the overall benefit. Qualified start-up costs encompass ordinary and eligible plan establishment, administration, and retirement-related education expenses. 

Adding an auto-enrollment feature to the start-up plan brings an additional tax credit of $500 per year for a three-year taxable period. These provisions apply to various retirement plans, excluding solo employee 401(k) plans. Employers should grasp the elective nature of both SECURE 1.0 Act and SECURE 2.0 Act credits, with the latter becoming effective after December 31, 2022.

In conclusion, understanding the intricate details of start-up tax credits under SECURE 2.0 Act is crucial for employers navigating the evolving landscape of retirement planning. Consultation with financial advisors and retirement plan experts becomes invaluable in optimizing these opportunities.

Contact your Marsh McLennan Agency retirement plan advisor to learn about SECURE 2.0 and how it affects your organization.