There may never be a better time to create a retirement plan

Small businesses have new incentives to help their employees plan for retirement, thanks to Secure 2.0, a sweeping retirement reform bill signed into law late last year.

The incentives, which include tax credits that are especially attractive to businesses with 50 or fewer employees, are designed in part to encourage small companies to create retirement plans for their employees — especially the smallest firms, among whom less than half (48%) offer a retirement plan, according to research by Anqi Chen and Alicia Munnell of the Center for Retirement Research at Boston College, which uses 2019 U.S. Bureau of Labor Statistics data. 

But that's changing, in part inspired by more attractive tax breaks and a highly competitive labor market in which every benefit matters more in the war for talent. Among companies not offering a 401(k) or similar plan, 42% say they are likely to begin sponsoring a plan in the next two years, according to a new survey report published May 2 by nonprofit Transamerica Institute and its Transamerica Center for Retirement Studies. Among those that are not likely to sponsor a plan in this time frame, 31% cited cost concerns. 

Before discounting plan sponsorship — especially for cost reasons — small businesses should consider the potential financial benefits Secure 2.0 has to offer. There are eligibility requirements and specific variables that can affect these benefits, so it makes sense to consult a tax advisor to help weigh the various options.

But as a general rule, these credits "add up to sizable benefits for employers looking to start plans," said Amy Vaillancourt, senior vice president of workplace product, strategy and architecture at Voya Financial.

Here are some basic features of the legislation and points to consider in balancing costs and benefits — to both employer and employee.

A big tax credit can cut down on plan setup costs

Secure 2.0 created a souped-up credit to offset administrative costs associated with starting a qualified retirement plan. For businesses with between one and 50 employees, the legislation increased the percentage of coverage up to 100% of qualified start-up costs, up from 50%. There's a $5,000 per year cap that's available for three years. Larger businesses — those with 51 to 100 employees — are still eligible to receive up to 50% of plan start-up costs.

Employer contributions also generate tax advantages

Additionally, Secure 2.0 offers a new tax credit for five years to businesses with up to 100 employees who make employer contributions to a new defined contribution plan. This credit is designed to encourage small businesses to contribute to their employees' retirement savings. The exact amount of the credit depends on factors such as the number of eligible employees and the number of years since the plan began.

The credit is especially beneficial to employers with 50 or fewer employees. For these businesses, the credit is up to $1,000 per year for each employee earning less than $100,000, and the amount of the credit reduces 25% each year starting in the third year, said Marc Scudillo, managing officer of EisnerAmper wealth management and corporate benefits. 

For larger businesses — those with 51 to 100 employees — the tax credit is based on a sliding scale.

Small businesses using the credit should talk to their tax preparer to understand how deductions for employer contributions will be reduced, said Kelly Gillette, a partner with accounting firm Armanino.

A smaller auto-enrollment credit can offset some costs

A $500 tax credit is available to small companies that add an automatic enrollment feature, available for the first three years, to a new or existing 401(k) plan. While this feature isn't required until 2025, small businesses could choose to do it now and get the credit earlier, Gillette said. While auto-enrollment tends to increase participation, and thus add costs for a small business, the credit could help offset these added costs.

Starter 401(k) plan doesn't require an employer match

Employers can now offer a starter 401(k) plan that allows them to take advantage of the applicable administrative tax credits even though they aren't making contributions on their employees' behalf, Scudillo said. Many small businesses don't want or can't afford to offer an employer match, but having this option can be a significant boon for employees. 

Seventy-one percent of respondents said they expect their primary source of income in retirement to come from what they save on their own in an employer-sponsored defined contribution plan, according to a recent survey from Natixis Investment Managers.

This new type of plan can be useful for recruiting purposes and for helping employees prepare for retirement, Scudillo said. The option is available to small businesses that do not have a plan in place.

Military families receive extra attention in legislation

Military spouses often lose out on the ability to save for retirement because they may not stay at a job long enough to qualify for retirement benefits or become vested. Secure 2.0 offers eligible employers a credit of up to $500 credit per military spouse that participates in the company's defined contribution plan, provided certain conditions are met.

For instance,  military spouses must be immediately eligible to participate in the plan within two months of hire. Also, upon plan eligibility, the military spouse must be eligible for any matching or nonelective contribution that he or she would have been eligible for otherwise at two years of service.

The credit applies for three years and does not apply to highly compensated employees.

New Roth IRA options for small businesses

Secure 2.0 allows business owners to offer a Roth version within SEP IRAs and SIMPLE IRAs. These are often used by small businesses because they tend to have less administrative responsibilities than a 401(k)," said Eric Bronnenkant, head of tax at Betterment. The ability to offer a Roth option in these plans could benefit the owner directly, but it is also helpful for recruiting and retention purposes, Bronnenkant said. 

The self-employed are not left out of legislation

The retirement legislation also has multiple benefits available for all individuals, including the self-employed. One of these benefits is the increased ability to contribute more money to retirement after age 50. For 2023, the catch-up contribution limit is $7,500, compared with $6,500 in 2022 for people ages 50 and above. Under Secure 2.0, the catch-up contribution limit will increase even more for participants between the ages of 60 and 63 starting in 2025, Gillette said.

Additionally, the age at which people must take required minimum distributions from their traditional 401(k) or traditional IRA has increased. Beginning in 2023, Secure 2.0 raised the age that a person must start taking RMDs to age 73. What's more, starting in 2024, there is no RMD requirement for Roth 401(k) and Roth 403(b) plans, so it puts them on par with a Roth IRA, which can also be a significant benefit, Gillette said.