Credits and incentives available to retirement plan sponsors

Executive summary: Credits for retirement plan sponsors

Continued concerns by congressional leaders for employees to attain retirement security have led to legislative changes intended to make it more affordable for certain employers to sponsor a retirement plan. Non-refundable credits were already in place to help employers offset the administrative cost of implementing and maintaining a retirement plan, but the SECURE 2.0 Act of 2022 (SECURE 2.0) enhanced an existing credit and introduced new start-up and military spouse credits to incentivize plan sponsors to maintain plans and make their setup and operation more feasible. SECURE 2.0 also provides plan sponsors the ability to use de minimis financial incentives to entice employees to elect to defer. The IRS provided additional guidance on these credits and financial incentives in Notice 2024-2.

Startup plan tax credits

Small employer pension plan startup cost tax credit

SECURE 2.0 expanded the already available small employer pension plan startup cost tax credit to make implementing a retirement plan more attractive to a small employer. A small employer in this context is an employer with 100 or fewer employees who earned at least $5,000 in the prior tax year. Employees of employers related to the sponsoring employer under the controlled and affiliated service group aggregation rules are considered for this purpose. Historically, small employers could claim a nonrefundable credit for 50% of the cost to set up and administer a retirement plan, up to a maximum of $5,000. Costs paid by the employer, not the plan, are considered for purposes of the credit. The credit has been increased to 100% for employers with 50 or fewer employees earning at least $5,000 in the prior tax year, beginning in 2023. The 50% credit still applies for employers with 51 to 100 employees. Generally, the credit can be claimed for the first three years the plan is in operation. Amounts claimed towards the credit cannot also be deducted as an expense on the employer’s return. The employer can elect whether it takes the credit each year, so if an employer does not claim the credit for a given year, the costs may be deducted. Since the credit is nonrefundable, it is not beneficial for tax-exempt and governmental employers.

Additional credit for employer contributions

Small employers who meet the criteria of the small employer pension plan startup cost tax credit also have the opportunity to receive an additional credit for employer contributions (e.g., profit-sharing or match) made to a new defined contribution plan, for taxable years beginning after Dec. 31, 2022. The credit, which is available for up to five years, is 100% of employer contributions (up to $1,000 per eligible employee) in the year a plan is established and the next, 75% in the third year, 50% in the fourth year, and 25% in the fifth year. For an employer with more than 50 employees in the prior year, the credit is reduced two percentage points for each employee in excess of 50 (i.e., if the employer had 60 employees, the credit would be reduced by 20%). Contributions to employees with more than $100,000 in compensation cannot be taken into account for the credit. Even with the limitations on this credit, it provides a potentially significant tax savings opportunity for small employers.

Auto-enrollment credit

Although not new with SECURE 2.0, another credit to keep in mind is the auto-enrollment credit, which allows a $500 credit for a three-year period, beginning in the year a small employer implements an auto-enrollment provision in their retirement plan. Auto-enrollment is a provision that enrolls eligible employees into a retirement plan at a specific deferral rate, unless the employee elects a different deferral rate or not to defer.

Summary

To conceptualize the credits potentially available, consider a 401(k) plan with an auto-enrollment provision effective in 2022 by an employer with less than 50 employees in every year.

Military spouse credit

A new credit, effective for taxable years beginning after Dec. 29, 2022, was born out of concern for military spouses who may not be able to participate in a retirement plan or may not become vested in their employer account within a retirement plan due to the need to frequently relocate. During each of the first three years in which a non-highly compensated military spouse participates in a defined contribution plan, SECURE 2.0 provides a tax credit of $200 for the military spouse’s participation plus an added credit of up to $300 for employer contributions made to the plan on behalf of the military spouse, subject to certain conditions. Conditions that must be met to qualify for the credit are:

• The military spouse must be allowed to participate in the plan within two months of employment.
• The military spouse must be immediately eligible for employer contributions at a rate at least as favorable as an employee who is not a military spouse would receive after two years of service.
• Employer contributions to the military spouse are immediately fully vested.

Small employers should keep in mind that the credit is based on each military spouse’s first three years of plan participation. Since each spouse could have a different three-year period, tracking the credit available for each year will require appropriate administrative measures.

Financial incentives for participants

Employers of all sizes often look for ways to increase the number of employees who elect to defer to a retirement plan. Historically, this has been in the form of targeted communication campaigns and financial literacy education of eligible employees. Beginning in 2023, SECURE 2.0 provided a new tool employers can use to entice employees to elect to defer. A de minimis financial incentive (not paid for with plan assets) can be offered to eligible employees who make a deferral election, provided they do not already have an election to defer on record.

In Notice 2024-2, the IRS noted a financial incentive will be considered de minimis if it does not exceed $250 in value. For example, as noted in the guidance, “if an employer announces on Feb. 1, 2024, that any employee for whom an election to defer under a CODA is not in effect on that date and who, within the next 90 days, makes an election to defer, will receive a $200 gift card, then the gift card is a de minimis financial incentive…”

Unless an exception is provided under the Internal Revenue Code, the financial incentive is considered includable in an employee’s wages and is subject to applicable employment tax withholding and reporting. For example, a gift card is a cash equivalent and considered to be a taxable fringe benefit. Therefore, no exception is available in this example and the value of the gift card is taxable compensation to the employee.

Takeaway

SECURE 2.0 expanded opportunities for employers to establish and operate retirement plans, especially for small employers. There are nuances involved in determining whether the credits are available and how the credit amounts are calculated. For example, specific criteria are applied to determine who is an eligible employer, how compensation is determined for the thresholds discussed, and to which years the credits can apply. RSM US can assist in evaluating credits or financial incentives available to employers sponsoring retirement plans, as well as for consulting on other retirement plan matters.

Stay tuned for other retirement plan topics each month and check out our previous article, Retirement plan audit and contribution considerations.

This article was written by Christy Fillingame, Lauren Sanchez, Toby Ruda and originally appeared on 2024-03-25.
2022 RSM US LLP. All rights reserved.
https://rsmus.com/insights/services/business-tax/credits-and-incentives-available-to-retirement-plan-sponsors.html

The information contained herein is general in nature and based on authorities that are subject to change. RSM US LLP guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. RSM US LLP assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein. This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer.

RSM US Alliance provides its members with access to resources of RSM US LLP. RSM US Alliance member firms are separate and independent businesses and legal entities that are responsible for their own acts and omissions, and each are separate and independent from RSM US LLP. RSM US LLP is the U.S. member firm of RSM International, a global network of independent audit, tax, and consulting firms. Members of RSM US Alliance have access to RSM International resources through RSM US LLP but are not member firms of RSM International. Visit rsmus.com/aboutus for more information regarding RSM US LLP and RSM International. The RSM(tm) brandmark is used under license by RSM US LLP. RSM US Alliance products and services are proprietary to RSM US LLP.