Most employers start 401(k) plans for the tax credits, deductions, and incentives. We'll learn more about all of these reasons below.
Offering a 401(k) plan can help set you apart from your competition and help relive much of the financial stress on your employees. Brian Halbert, founder of Halbert Capital Strategies noted, “The single largest benefit coming from a 401(k) is financially wise employees that have a zeal for working hard for their company.”
Not only can a plan incentives employee's to work harder but studies show the benefit often encourages employees to stay with you longer. Voya Financial research reported that “60% of workers are more likely to stay with their current employer if they offer an employer-sponsored retirement plan.”
Don’t miss out on the opportunity to encourage, delight and incentive employees.
According to Plan Sponsor Data and Research “73% of employees said that they expect employers to offer a 401(k) or 403(b) retirement plan because of the tight labor market. 98% of respondents said they think it’s important for their employer to offer a retirement benefit for employees at the workplace.”
Not offering a plan can be a real sore spot when trying to recruit todays best and brightest. Don’t miss out on your opportunity to capture the best talent in your field.
Employers with no more than 100 employees who received compensation of more than $5,000 in the previous calendar year, and who have not offered a plan in the previous three tax years. The amount of tax credit you qualify for is dependent on how many employees you had last year.
Employers who are starting a plan for the first time are eligible to receive significant tax credits for doing so. The SECURE act 2.0, passed in December 2022, enhanced the employer 401(k) administration credit to 100% of annual costs with a cap of $5,000. This credit is calculated by multiplying the number of eligible employees who earned more than $5,000 in the previous calendar year by $250.
This credit is available to employers in each of the first three years that they start a 401(k) plan. Eligible employees are defined as anyone who earned more than $5,000 in the previous calendar year who also made less than $150,000. Employees who have since been terminated still count on your behalf.
The SECURE act 2.0 also created a tax credit to help employers offset the cost of a company match. Employers with 50 or fewer eligible employees will receive a credit of $1,000 per employee. That’s $1,000 free dollars for you to give your employees! If you don’t take advantage of this credit your competitors will and they may then have an edge in the employee marketplace.
For the Match Credit, eligible employees are defined as anyone whom you paid more than $5,000 in the previous calendar year, who also made less than $100,000. Employees who have since been terminated but landed in the $5,000 -$100,000 range in the previous calendar year still count on your behalf.
The match credit is slowly phased out over the course of 5 years on the following schedule:
In some cases when the personal taxable income, tax deductions and tax credits are taken into consideration, employers can actually find themselves cash flow positive while offering a great benefit to their people.
Employers with over 50 employees:
Employers with more than 50 employees, who are starting a plan for the first time are eligible to receive significant tax credits for doing so. The SECURE act, passed in December 2019, created an employer 401(k) administration credit equal to 50% of annual costs, with a cap of $5,000.
This credit is available to employers in each of the first three years they start offering a 401(k) plan. Eligible employees are defined as anyone who you paid more than $5,000 in the previous calendar year, who also made less than $150,000. Employees who have since been terminated still count on your behalf.
The SECURE act created a tax credit to help employers offset the cost of a company match. Employers with 50 or fewer eligible employees will receive a credit of $1,000 per employee. For each employee over 50 the $1,000 credit is diminished by 2%. For example, if you had 61 eligible employees, you could expect to receive a credit of $780.00 for each. That’s $50,000 free dollars for you to give your employees! If you don’t take advantage of this credit your competitors will, and they may have an edge in the employee marketplace.
For the Match Credit, eligible employees are defined as anyone who you paid more than $5,000 in the previous calendar year, who also made less than $100,000. Employees who have since been terminated but landed in the $5,000 -$100,000 range in the previous calendar year still count on your behalf.
In some cases when the personal taxable income, tax deductions and tax credits are taken into consideration, employers can actually find themselves cash flow positive and offer a great benefit to their people.
If the federal tax credits weren’t already enough, there are even more tax incentives for offering a 401(k) plan. For 2023, the maximum individual tax-deferred contribution allowed by the IRS for those under 50 years old is $22,500 and up to $30,000 for those over the age of 50.
Decreasing the individual tax liability for both employees and employers who choose to participate.
Many employers also choose to make a matching contribution to employees’ 401(k) accounts. When these contributions exceed the tax credits previously explained they are considered an expense to the business and are tax deductible. Profit-sharing contributions to employees’ 401(k) accounts are also common. These types of employer contributions are also a tax deduction, further reducing the tax liability for small businesses.
401(k) plans are extremely flexible and can be designed in an almost infinite number of ways. The way you design your plan can drastically change the benefit employees and business owners receive from the plan.
Below are a few questions to consider when considering how to design your plan.
Objective is the first piece of the puzzle. Some employers want to save as much as they can personally while making the minimum employee contribution necessary, some have key employees that really matter to the business who they would like to target with higher contributions, and others want to reward all employees by doing as much as they can to help all employees prepare for retirement.
Narrowing down what you want to get out of your plan can help us decide what features you do and don’t want active in your document.
Offering a match can help increase your participation and retirement readiness of your participants. Giving a certain minimum level of employer contribution can deem your plan to be Safe Harbor and allow you to avoid the discrimination testing that often hinders owners and highly paid employees.
When and how you choose to calculate your employer contribution can have a large effect on both company finances and the way the IRS will test your qualified plan. This plan feature is usually the most important piece in recruiting and retaining employees.
Eligibility requirements can help you reduce the cost of an employer contribution. The IRS allows employees to be enrolled immediately after hire, 12 months after hire, or anywhere in-between.
Vesting is a great plan design tool available to employers. Employers are able to set service requirements for employees before the employer contribution becomes theirs to keep. If an employee leaves the company or is terminated before they are vested in the company match. Some, or all, the employer contribution they have accumulated will revert back to the plan.
Employers can use these surrendered funds to pay plan fee’s or offset future match.
The IRS requires that at least 70% of your non-highly paid employees are covered by your plan. Sometimes employers have groups of employees (like interns or leased employees) whom they do not ever want to receive company match. Consider if there are any groups of employees you employ that fall into this category.
Similar to the coverage test described in question 5, there are several tests we must run to ensure the plan isn’t benefiting one group of employees too much more than others. These discrimination tests are called the Top Hat, Top Heavy, ACP, and ADP tests. Together these tests sure up many of the ways employers would like to use the plan to target key individuals. However, if you are willing to make a minimum profit-sharing contribution you can ensure that these tests are satisfied, and you are able to make larger company contributions to specific employees.
Balancing whether the minimum profit sharing to all your employees is worth the added benefit of increased company match, is the key question when considering using a plan design to target these employees. The minimum contribution will vary between 3% and 10% of an employees pay. If you would like a more exact number, reach out to one of our specialists. After gathering a few general pieces of census data our team can calculate the maximum level of disparity while still satisfying the year end discrimination tests.
The name “Mega Back Door Roth” is a nick name given to a plan feature that allows some plans participants to reach the 415 limit. Using this feature in your tax-shelter strategy can allow high income earners to save significantly more to their 401(k) accounts….
How you answer these and many other plans design questions can dramatically change the look, feel and benefit of your retirement plan. Over the course of 20+ years, the RPC team has held over a thousand adoption consultations intended to help business owners create the perfect 401(k) plan offering. As time goes on, objectives and financial situations change. Retirement Plan Consultants will be with you ever step of the way.