Three tax credits that can help small businesses start a 401(k)

A business with 100 or fewer employees that starts a retirement plan can claim federal tax credits for setup costs, for automatic enrollment, and for the company's own contributions. Here is how each one works and where the limits are.

Owners thinking about a 401(k) often stop at the cost. Three federal tax credits, two of them expanded or created by SECURE 2.0 starting in 2023, can cover a real part of the first few years. They are credits, not deductions, so they reduce the tax owed dollar for dollar.

Who can claim them

The credits are for employers with 100 or fewer employees who earned at least $5,000 in the prior year. The plan needs at least one participant who is not highly compensated. And the plan has to be new: if the business, or a related one, covered substantially the same employees in another plan in the past three years, the credits generally do not apply.

1. The startup cost credit

This credit pays back the cost of setting up and running the plan, and of educating employees about it, for the first three years.

• 50 or fewer employees: 100% of eligible costs.
• 51 to 100 employees: 50% of eligible costs.

Either way, the yearly cap is the greater of $500 or $250 for each eligible non-highly compensated employee, up to $5,000.

2. The employer contribution credit

This is the credit tied to the match. It covers money the company puts in for employees, such as a match or a profit-sharing contribution, up to $1,000 per employee per year. It does not cover what employees save from their own pay.

It phases down over five years:

Year (year 1 = the year the plan starts): Share of employer contributions credited

• Year 1: 100%
• Year 2: 100%
• Year 3: 75%
• Year 4: 50%
• Year 5: 25%
• Year 6 on: 0%

Two limits matter. Contributions for anyone earning more than $100,000 do not count; that figure was set for 2023 and is adjusted for inflation. And for employers with 51 to 100 employees, the percentage drops by 2 points for each employee over 50.

3. The automatic enrollment credit

A plan that enrolls employees automatically can claim $500 a year for three years. This one also applies to an existing plan that adds the feature.

A simple illustration

Take a hypothetical company with 20 employees, all earning under the wage limit, that matches up to $1,000 for each of them. In the first two years, the contribution credit could equal the full $20,000 of match. In year three it would be $15,000, then $10,000, then $5,000, then nothing. The startup and automatic enrollment credits would come on top, within their own limits. Actual results depend on who participates, what the plan costs, and the company's tax situation.

The tradeoffs

• The credit ends; the match does not. From year six the company pays the full cost of whatever match it chose. Set a match the business can carry without the credit.
• No double benefit. Costs and contributions covered by a credit cannot also be deducted.
• Higher earners are left out. The contribution credit does not count owners or staff above the wage limit.
• It has to be claimed. The credits are claimed on IRS Form 8881 with the business tax return. Your CPA should run the numbers before you count on them.

Where to start

Get a count of employees who earned at least $5,000 last year, and how many earn under the wage limit. Get a quote for what the plan would cost to run. With those two numbers, a CPA can estimate the credits year by year.

If you would like help weighing a new plan, request a plan review.

Sources: Internal Revenue Code Section 45E, including subsection (f); IRS, "Retirement plans startup costs tax credit" (page updated May 31, 2026).