Want to improve your chances of hiring and keeping your star employees? Offer them retirement benefits.

According to an Employee Benefit Research Institute report, quality retirement savings benefits are among the top five most valuable benefits for employees of all age groups.

Of course, offering these benefits isn’t cheap. The startup costs alone are enough to scare off some small business owners. Fortunately, the retirement plans startup costs tax credit makes it easier to take that first step, reducing the financial burden and making it more feasible for small businesses to offer these benefits.

Yes, Uncle Sam is throwing you a bone, so let’s dive into how this tax credit works and how it could save you money.

What is the retirement plans startup costs tax credit?

This tax credit is a government incentive designed to encourage small businesses to establish qualified retirement plans, such as a 401(k), SEP-IRA, or SIMPLE IRA. The credit helps offset the cost of starting and maintaining the plan during its first three years.

Who qualifies for this tax credit?

The IRS has laid out a few key criteria for eligibility:

1. You must have 100 or fewer employees who were paid at least $5,000 in the previous year
2. You didn’t already have a qualifying plan in place for the same employees during the three tax years prior
3. At least one participant in the plan must be a non-highly compensated employee (NHCE)

If your business checks these boxes, you’re in the game!

What is a non-highly compensated employee?

According to IRS Publication 560, a highly compensated employee is anyone who:

• Owned more than 5% of the interest in the business at any time during the year or the prior year, regardless of how much compensation they received or
• Received compensation of more than $155,000 in 2024 and was in the top 20% of employees when ranked by compensation (that compensation limit changes annually with inflation)

So as long as at least one participant in your plan doesn’t meet this definition of highly compensated, you’re good to go!

How much is the startup tax credit worth?

The startup tax credit actually consists of three parts:

Qualified startup costs

The amount of the credit depends on how many employees you have. If you have 50 or fewer employees, your credit is 100% of eligible startup costs, up to the greater of:

• $500, or
• The lesser of $250 multiplied by the number of NHCEs eligible to participate in the plan or $5,000.

If you have 51-100 employees, your credit is 50% of eligible startup costs, up to the greater of:

• $500, or
• The lesser of $250 multiplied by the number of NHCEs eligible to participate in the plan or $5,000.

So essentially the maximum qualified startup costs credit is $5,000 per year, meaning you could save up to $15,000 over three years.

Not too shabby, right?

Auto-enrollment tax credit

If your plan includes automatic enrollment, you may be eligible for an additional $500 tax credit per year for three years. This credit is available for new or existing plans that adopt an eligible auto-enrollment feature.

Think of it as a little extra motivation to set up a plan that encourages employees to save consistently—because we all know procrastination is a thing.

Employer contributions

The SECURE 2.0 Act added an additional credit for employer matching or profit-sharing contributions for the first five years of the plan.

The employer contribution tax credit potentially covers:

• 100% of employer contributions for the first two years of the plan
• 75% in year three
• 50% in year four
• 25% in year five

This credit is available to businesses with up to 100 employees, but the credit phases out by 2% per employee over 50 employees earning less than $100,000 per year. The credit is based on a maximum contribution of $1,000 per year for each of those employees.

Keep in mind that you can’t claim a tax deduction and a credit based on the same expenses.

Bonus credit for hiring a military spouse

Small employers that hire a military spouse may be eligible for an extra tax credit. To qualify, the military spouse:

• Cannot be an HCE
• Must participate in the plan within two months of being hired
• Should be eligible for matching or nonelective employer contributions as if they were employed for two years and
• Must be 100% vested in all contributions

If the employee qualifies, you can claim an additional $200 tax credit, plus 100% of the contributions made on their behalf, up to $300. In other words, the maximum tax credit is $500, and it’s available for the first three years they participate in your 401(k) or other qualified plan.

What counts as “startup costs”?

The IRS defines startup costs pretty broadly, which is great news for small business owners. Here are some common expenses that qualify:

• Legal, consulting, or administrative costs to establish the plan
• Costs to educate employees about the plan
• Any costs associated with setting up a payroll system to handle plan contributions

Essentially, if the expense is tied to getting your plan off the ground and running, it likely counts.

How to claim the retirement plan tax credits

Claiming any aspect of the retirement plans startup costs tax credit is pretty straightforward. These credits are available on Form 8881, Credit for Small Employer Pension Plan Startup Costs, Auto-Enrollment, and Military Spouse Participation.

It’s a one-page tax form, so you just need to fill it out and include it when you file your federal income tax return.

If filling out tax forms gives you hives, don’t worry. That’s what tax professionals are for!

Ready to get started?

If you’re considering setting up a retirement plan but aren’t sure how to take advantage of the tax credit, Countless is here to help. Contact us today, and we’ll guide you through the process, ensure you maximize your credit, and help you select a retirement plan that benefits you and your employees.

Don’t leave money on the table. Reach out to Countless now and see how we can help your small business get the most out of the Retirement Plans Startup Costs Tax Credit!