In today’s competitive business landscape, offering a retirement plan isn’t just a perk—it’s a powerful tool for attracting and retaining top talent. However, for many small businesses, the financial burden of setting up and maintaining these plans can be daunting. The good news? The IRS offers a compelling incentive through Section 45E of the Internal Revenue Code, providing a valuable tax credit to offset employer contributions to new retirement plans.
Let’s explore how the Sec. 45E credit works, who qualifies, and why small businesses should take advantage of this opportunity.
What Is the Sec. 45E Credit?
The Sec. 45E tax credit is a federal incentive designed to encourage small businesses to establish and contribute to employee retirement plans. Eligible employers can claim a credit of up to $1,000 per employee for employer contributions, helping offset the initial costs of setting up and funding these plans.
This credit, introduced as part of the SECURE 2.0 Act, aims to boost retirement savings by making it easier for small businesses to offer retirement benefits.
Eligible Retirement Plans
To qualify for the Sec. 45E credit, the retirement plan must be a new, qualified plan, including:
- 401(k) Plans
- Simplified Employee Pension (SEP) IRAs
- Savings Incentive Match Plan for Employees (SIMPLE) IRAs
- Qualified Defined Benefit Plans
The plan must not have been in place for the three tax years prior to the year in which it becomes effective. This requirement ensures the credit supports new retirement plans rather than subsidizing existing ones.
Employer Contributions That Qualify
The credit applies to employer contributions, including:
- Matching contributions (when employers match a percentage of an employee’s salary)
- Non-elective contributions (fixed employer contributions regardless of employee contributions)
Importantly, defined benefit plans are excluded from this credit. Additionally, contributions made for employees earning over $100,000 annually (adjusted for inflation after 2023) are not eligible for the credit.
Who Can Claim the Sec. 45E Credit?
To qualify for the tax credit, an employer must:
- Have no more than 100 employees, each earning at least $5,000 in the previous tax year.
- Not have offered a retirement plan covering substantially the same employees in the past three years.
This eligibility criterion ensures that the credit is targeted toward small businesses that need additional financial support to establish retirement plans.
Phase-Out Based on Employee Count
The tax credit amount gradually phases out for businesses with more than 50 employees. Specifically, the credit is reduced by 2% for each employee beyond this threshold. This structure ensures that smaller businesses receive the most substantial benefit, easing their financial burden in setting up retirement plans.
Employee Qualifications for the Credit
Employees covered under the credit must:
- Earn at least $5,000 in compensation from the employer in the preceding tax year.
This ensures that the credit supports contributions for actively engaged employees, fostering long-term retirement savings for the workforce.
Phase-Out of the Credit Over Five Years
The Sec. 45E credit is available for a total of five years, with a structured phase-out:
- Years 1 & 2: 100% of eligible contributions (up to $1,000 per employee)
- Year 3: 75% of eligible contributions
- Year 4: 50% of eligible contributions
- Year 5: 25% of eligible contributions
This gradual reduction encourages businesses to continue making contributions while easing them into full financial responsibility over time.
How Sec. 45E Fits into the General Business Credit
The Sec. 45E credit is part of the General Business Credit, meaning employers can carry back unused credits for one year or carry them forward for up to 20 years. This flexibility allows businesses to optimize their tax benefits based on profitability and tax planning strategies.
Effective Years for the Sec. 45E Credit
The credit, as amended by the SECURE 2.0 Act, applies to tax years beginning after December 31, 2022. Employers can begin claiming the credit for qualifying contributions made in 2023 and beyond.
Why Small Businesses Should Take Advantage of This Credit
For small businesses without a current pension or retirement plan, the Sec. 45E credit provides a strong financial incentive to start one. Here’s why this matters:
- Tax Savings – The credit reduces the net cost of employer contributions.
- Competitive Advantage – Offering a retirement plan helps attract and retain top talent.
- Employee Satisfaction – Workers value retirement benefits, boosting morale and loyalty.
- Long-Term Business Growth – Supporting employees’ financial security fosters a stronger, more committed workforce.
Final Thoughts
The Sec. 45E tax credit is an excellent opportunity for small businesses to enhance employee benefits while reducing tax liabilities. With the recent updates under the SECURE 2.0 Act, now is the perfect time to explore how this incentive can benefit your business.
Need help understanding how to maximize this credit for your business? Contact us today, and let’s discuss how you can take advantage of this valuable tax incentive!
