Safe Harbor 401(k) Tax Credits
Siân Killingsworth / 5 Aug 2022 / Safe Harbor 401k
The most highly valued benefit of Safe Harbor 401k plans is that small business owners automatically satisfy non discrimination testing allowing them to maximize their deferrals without worry of a failed test. But did you know that choosing to set up a Safe Harbor retirement savings plan also qualifies small businesses for special tax credits to offset administrative costs? It’s true – the Safe Harbor provision can help you bring down your corporate taxes, and the savings can be applied to running the plan itself.
Who Qualifies for Safe Harbor Tax Credits?
As of January 2020, the SECURE Act permits qualified small businesses to claim a tax credit (of up to $5,000 per year for the first three years) for adopting a new 401(k) retirement plan, regardless of the plan’s Safe Harbor status.
To qualify, a small business must have 100 or fewer employees who received at least $5,000 in compensation in the preceding year, had at least one non highly compensated employee, and you must not have had a 401(k) or qualifying retirement plan within the last three years.
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What Tax Credits Apply to Safe Harbor 401(k) Plans?
There are two types of tax credits that apply to small business 401(k) plans:
The New Plan Tax Credit
The SECURE Act tax credit lets qualified small businesses claim up to $5,000 in tax deductions per year for up to three years. They can save up to a total of $15,000 when they establish a new 401(k) plan.
The Auto-Enrollment Tax Credit
Small business employers can also claim $500 a year (for three years) by adding an auto-enrollment feature to a new or existing plan. When you choose auto-enrollment, all eligible employees will be entered into the plan at a base rate of 3% pay, which automatically increases by 1% each year until reaching a maximum of 15%. Employees can opt out or modify their savings rate at any time without affecting the small business tax credit.
In summary: you can claim a maximum of $5,500/year — or $16,500 in total — over a three-year period.
Additional Benefits of Safe Harbor 401(k) Plans
The tax credit opportunity is just one of the many reasons small businesses consider a Safe Harbor 401(k) plan.
Safe Harbor small business 401(k)s require employer contributions. You can choose from several contribution formulas: You can contribute in one of two ways:
- A non-elective contribution worth 3% pay to every eligible employee in the plan.
- A basic or enhanced matching contribution which is immediately 100% vested.
- A sample basic match might be 100% on the first 3% and 50% on the next 2%.
- A sample enhanced match might be a 100% match on the first 4%.
At tax time, you can also write off any amount contributed as a tax-deductible business expense, which may lower your tax bill.
Also, because you will automatically pass the IRS non-discrimination tests, you won’t have the stress or potential penalties from noncompliance as a financial concern.
If you have questions about 401(k) retirement plans for your small business, including how to take advantage of Safe Harbor tax credits, contact Ubiquity — one of America’s top providers of low-cost, flat-fee small business 401(k)s.