The Retirement Plan Startup Credit: How the Government Pays Small Businesses to Offer a 401(k)

 

Most small business owners assume starting a retirement plan is a cost they'll absorb to stay competitive on hiring. For many businesses, that's no longer true. Between the startup cost credit, the employer contribution credit, and the auto-enrollment credit under Internal Revenue Code Sections 45E and 45T, a small employer can have most, sometimes all, of the cost of launching a new plan offset by the federal government for several years running.

 

This is one of the most underused credits we see, largely because it's easy to assume it doesn't apply, or that the numbers aren't meaningful. They usually are.

 

The Startup Cost Credit (Section 45E)

 

If you're establishing a new SEP, SIMPLE IRA, 401(k), or other qualified plan, the ordinary and necessary costs of setting it up and administering it, think TPA fees, recordkeeping, and employee education, can generate a credit of:

 

• 100% of qualified startup costs for employers with 1–50 employees

• 50% of qualified startup costs for employers with 51–100 employees

 

The credit is capped each year at the greater of $500, or $250 multiplied by the number of non-highly-compensated employees eligible to participate, up to a maximum of $5,000 per year. It's available for the first credit year and the two years that follow, up to three years total.

 

To qualify, the employer must:

 

• Have had no more than 100 employees who received at least $5,000 in compensation in the prior year, and

• Not have maintained a plan covering substantially the same employees at any point in the preceding three tax years.

 

That second condition is important — this credit is aimed squarely at first-time adopters, not businesses switching providers or restating an existing plan.

 

The Employer Contribution Credit (Also Section 45E)

 

This is the credit most businesses don't realize exists. Separate from the startup cost credit, employers with 100 or fewer employees can claim a credit for their own matching or nonelective contributions to the plan, up to $1,000 per employee per year, excluding highly compensated employees (generally those earning over $100,000, indexed for inflation) and excluding elective deferrals.

 

The credit phases down over five years:

 

Year Credit % of Contribution

1        100%

2       100%

3        75%

4        50%

5        25%

 

For employers with 51–100 employees, the credit is reduced based on the number of employees above 50. Below a certain size, this credit alone can fully offset an employer's contributions to the plan for the first two years.

Example: A business with 12 employees contributes $1,500 on average to each of 9 eligible employees in year one, $13,500 total. Capped at $1,000 per employee, the credit is $9,000 in year one alone, on top of whatever startup cost credit applies.

 

The Auto-Enrollment Credit (Section 45T)

 

Separately, employers that add an eligible automatic contribution arrangement to a new plan can claim an additional flat $500 credit per year, for up to three years. It's a small credit on its own, but auto-enrollment plan designs also tend to boost participation rates and can help a plan pass nondiscrimination testing, a second-order benefit worth more than the credit itself for some employers.

 

Why This Gets Missed

 

Two reasons, mostly:

 

1. Business owners assume it's not worth the paperwork. For a business with a handful of NHCEs, the numbers above can add up to thousands of dollars annually for very little incremental effort — the credit is claimed on Form 8881 alongside the general business credit.

 

2. Timing matters, and it's easy to miss the window. The "first-time adopter" requirement means a business that already has a plan can't retroactively qualify. If a client is weighing whether to finally set up a 401(k), the tax credit is often the deciding factor — but only if it's raised before the plan is established, not after.

 

The Planning Angle

 

This credit is a natural conversation to have with any profitable small business that doesn't yet offer a retirement plan, particularly ahead of year-end, when the decision to establish a plan for the current year is still on the table. It's also worth revisiting for businesses that established a plan in the last one to three years but never claimed the credit; Notice 2024-2 confirms that employers can still claim the enhanced SECURE 2.0 credit amounts for the remaining years of their original three- or five-year window, even if the plan was established before the law changed.

 

For a business owner, a new retirement plan stops looking like a benefits expense and starts looking like a multi-year tax strategy that also happens to help retain employees.