Maximize Your Savings: Tax Credit Opportunities for New 401(k) Plans

Retirement planning is essential to your future financial security, and one of the most effective tools for doing so is a 401(k) plan. Fortunately, there are great benefits to both employers and employees when it comes to the setup of a 401(k) plan.

To incentivize small businesses to offer retirement benefits to employees, the government offers tax credits for establishing new 401(k) plans. Understanding these tax credits can help both employers and employees make the most of their retirement savings opportunities.

What is a 401(k) Plan?

A 401(k) plan is a retirement savings account sponsored by an employer. It allows employees to save and invest a portion of their paycheck pre-tax or Roth. These contributions grow tax-deferred until withdrawal during retirement, or tax free if in Roth, potentially providing substantial savings over time. Many employers also offer matching contributions, further boosting the retirement savings of their employees.

Tax Credits for New 401(k) Plans

Small businesses face various challenges when it comes to offering retirement benefits, including administrative costs and regulatory complexities. To encourage small businesses to provide retirement plans to their employees, the government offers tax credits for establishing new 401(k) plans.

The IRS provides the Small Employer Pension Plan Startup Cost Tax Credit, which allows eligible small businesses to claim a tax credit for a percentage of the ordinary and necessary costs of starting a qualified retirement plan. This credit can be as high as $5,000 per year for the first three years of the plan. To be eligible, the business must have 100 or fewer employees who received at least $5,000 in compensation from the business for the preceding year.

Another credit available to new 401(k) plans with under 100 employees is a $500 credit for Automatic Enrollment. If your plan automatically enrolls employees into the 401(k) plan you can claim this $500 credit for the first 3 years of the plan.

A third credit available to new 401(k) plans is an Employer Contribution Credit. This credit can be claimed for 5 years with a reduction in the max credit each year. This could equate to a $1,000 credit per employee if an employer makes a $1,000 contribution to each employee. Actual calculation is determined by number of employees and employer contributions made.

These credits can significantly offset the initial expenses associated with setting up the plan, making it more feasible for small businesses to offer retirement benefits to their employees.

Benefits for Employers

Apart from the tax credits, there are several benefits for employers who offer 401(k) plans:

  1. Attract and Retain Talent: Offering a retirement plan can make a small business more attractive to potential employees and help retain current employees by providing valuable benefits.
  2. Tax Advantages: Employers can also benefit from tax advantages by deducting their contributions to the plan as a business expense.
  3. Employee Morale: Providing a 401(k) plan demonstrates a commitment to the financial well-being of employees, which can boost morale and productivity in the workplace.

Benefits for Employees

Employees also reap significant advantages from participating in a 401(k) plan. It’s important to note that all of the benefits for employees will generally apply to the business owners (employers) as well, since they are also employees:

  1. Tax Deferral: Contributions to a 401(k) plan can be made on a pre-tax basis, reducing taxable income and potentially lowering tax liabilities.
  2. Tax- free growth: Contributions made on a Roth basis are taxed today for tax free money in retirement.
  3. Employer Matching: Many employers offer matching contributions to employee 401(k) contributions, effectively doubling their retirement savings.
  4. Long-Term Growth: Investments within a 401(k) plan grow tax-deferred, allowing savings to compound over time and potentially accumulate substantial wealth for retirement.

Establishing a new 401(k) plan offers both employers and employees numerous benefits, and tax credits provided by the government can help offset the initial costs for small businesses. By taking advantage of these tax credits, small businesses can provide valuable retirement benefits to their employees while enjoying tax advantages themselves. Ultimately, investing in retirement savings not only secures financial futures but also contributes to the overall well-being and stability of employees and businesses alike.

At Copper Leaf Financial we understand the importance of tax strategizing and how it will impact your overall financial plan. We use our in-depth expertise to help minimize your tax liability and create a long-term plan.

This is published by Copper Leaf Financial as a service to our clients, business associates and friends. Recipients should not act on the information presented without seeking prior professional advice. Check with your advisor about your specific situation. Additional guidance may be obtained by contacting us at 802.878.2731.

Written by Breanna Sykes, CFP®, Senior Wealth Advisor, Copper Leaf Financial