Huge Opportunity for New Start-up 401(k) Plans
Congress and the President agreed that more small businesses need to have a 401(k) plan. Congress had previously tried to address this concern by providing a tax credit to offset the start-up costs of establishing a plan and administering the plan for the first three years. The credit was for small businesses with no more than 100 employees and at least one non-highly compensated employee (NHCE - for 2020 it is employees making less than $130,000 per year), and previously without a plan. Previously this credit had been capped at $500 per year, so it really did not drive behavior as intended. So the stakes have been raised...
When the SECURE Act recently passed, it changed the tax credit available beginning January 1, 2020. Under SECURE, the amount of the tax credit for a company is now capped at $250 times the number of NHCEs eligible to participate in the plan up to a $5,000 annual maximum (but never less than $500), though, as we saw with prior law, the credit is still limited to 50% of the start-up costs.
In addition, if the new plan automatically enrolls employees into the plan on a uniform basis (but at no minimum rate), the employer will get an additional annual credit for start-up costs of $500 per year. Amazingly, all of this is effective Jan. 1, 2020. Yes, effective for new plans beginning right now!
For example, take a small business employer with 10 NHCEs that wants to establish a safe harbor 401(k) plan for her employees and is willing to do automatic enrollment. The provider quotes an out-of-pocket document fee of $1,500 and annual cost to the employer of $1,500 per year. In that case, the tax credit available to this employer will be $750 (the lesser of $2,500*50% or $750) plus $500 or $1,250, which covers almost half of the first year cost, and almost all of the cost for the next two plan years. Out of pocket cost for this particular Plan Sponsor would be $1,750 in year one, and $250 in years two and three.
This can also be one of the most dangerous times for a Plan Sponsor. They are setting up a plan now to take advantage of cost-reducing tax credits, but if they let themselves be put into someone's "box" they can give all that money back. Many of the least expensive recordkeepers or Third Party Administrators (TPAs) offer their best "price" to those who take a limited plan design - typically a Safe-Harbor, often a non-elective Safe Harbor. It does a Plan Sponsor no good to save $3,750 in costs if they turn around and give all that money away through unnecessary contribution or vesting requirements. Plan design is critical at this stage, but many advisers or recordkeepers become so focused on setting the plan up quickly that they miss this huge potential cost. Look for a TPA that focuses on plan design. It may take a few extra minutes, but it will be well worth it in the long run.