Enhanced tax credit entices more companies to offer 401(k) plans

In October — as many businesses struggled with reduced staff — Damon Deru did what he had long wanted to do. He introduced a 401(k) plan for his company's 16 employees.

The founder and CEO of AdvisorPeak Inc., a Layton, Utah-based provider of trading and rebalancing software for financial advisers, was moved to launch the 401(k) partly because of a tax credit that would help offset the plan's cost.

Though many factors played into his decision, the tax credit "helped push us in the right direction," Mr. Deru said.

The tax credit — newly fattened under the SECURE Act — is available to employers with up to 100 employees for three years and is equal to 50% of their retirement plan costs, up to an annual cap of $5,000. That's 10 times the previous cap of $500.

For more and more small business owners like Mr. Deru, the more generous tax credit is getting them over the finish line, raising hopes among industry observers that the nation's retirement coverage gap may eventually begin to close. Adding to that optimism is the ongoing rollout of pooled employer plans, a new type of 401(k) offering that allows multiple employers to provide a joint — and ideally lower-cost — plan.

Indeed, some record keepers have reported heightened interest among small employers in offering retirement plans. Guideline Inc., a San Mateo, Calif.-based digital record keeper, for example, has seen sharp growth in the number of first-time plans, signing up 6,510 plans nationwide in 2020, up 43.4% from 4,539 in 2019. The pace has been equally brisk this year with the firm on track to exceed last year's total. As of April 26, Guideline had more than 3,000 startup plans, accounting for 95% of all new plans, up from 93% in 2020 and 89% in 2019.

"The increased tax credits are really impactful," said Jeff Rosenberger, Guideline's chief operating officer. "Seeing the acceleration of new plans, it's pretty clear it's a factor here."

Principal Financial Group has also seen strong gains, posting a 20% year-over-year increase in the number of first-time plans in the first quarter, an increase it attributes at least in part to the tax credit.

"The newly enhanced tax credit was certainly a factor," said Lance Schoening, Principal's Des Moines, Iowa-based director of policy. Mr. Schoening declined to say how many startup plans had joined Principal's platform in the first quarter, saying he could not share raw numbers.

Clearly, the tax credit is only part of the story behind the uptick in first-time plans. Expectations of a recovering economy and an anticipated hiring boom — not to mention looming employer deadlines to join certain state-mandated retirement plans — are pushing employers to offer their own workplace plans, according to industry experts.

AdvisorPeak's Mr. Deru, for instance, had wanted to offer a plan since starting the company in November 2018, a desire that intensified as he stepped up the company's recruiting and retention efforts. "Being able to provide a retirement plan to our employees was something that was really important not only for the employees that have been with us for a while, but also to attract new employees as well," he said.

For Mr. Deru, the tax incentive nevertheless helped solidify his decision. "It was definitely a determining factor when we were deciding to start up the plan," he said. Mr. Deru chose 401GO Inc., a digital 401(k) provider that he said charges "extremely reasonable fees."

"I wouldn't say employers are making decisions exclusively on the credits but it's definitely tipping the scales for many employers," said Aidan Yeaw, principal of 401(k) Gee(k) Consulting in Boston.

Principal's Mr. Schoening echoed the same view, saying that for employers at the "end stage" of the decision-making process, the tax credit is especially important. "We can point to the fact that the credit is now really a key discussion point for every small business that's considering a plan with Principal," he said.

Indeed, the tax credit would for the most part cover employer startup plan costs for the first three years. Guideline's Mr. Rosenberger, for example, says that the tax credit would cover the startup cost for the vast majority of its clients. The online record keeper charges a monthly base fee of $39 plus a monthly per participant fee of $8.

Principal, too, says the tax credit would fully offset the costs that the employer would have to bear for the first three years of service on its digital record-keeping platform for first-time plans. The record keeper charges a $150 monthly record-keeping fee, a monthly per participant fee of $6, plus a $500 one-time setup fee.

Still, some observers say more can be done to entice a greater number of small businesses to offer retirement plans. The Insured Retirement Institute, a trade association for money managers and other financial services firms, is pushing for a stronger incentive.

"We don't think it has had the fully desired impact yet that it was designed to have," said Paul Richman, IRI's Washington-based chief government and political affairs officer, referring to the current tax credit. Mr. Richman noted that according to the Bureau of Labor Statistics, more than 50% of private-sector workers employed by a small business with 50 or fewer employees don't have access to a defined contribution retirement savings plan.

Kent Mason, a partner at Davis & Harman LLP in Washington, also thinks that more should be done to help small businesses, particularly those among the smallest. "I think it was a big improvement, but I don't think it was enough," he said, referring to the current tax credit.

Two bills expected to be reintroduced in Congress include provisions that would boost the credit for the smallest employers with 50 or fewer employees, the segment of the employer market where the retirement coverage gap is most severe.

The legislative proposal in the Senate — the Retirement Security and Savings Act last introduced by Sen. Rob Portman, R-Ohio, and Sen. Ben Cardin, D-Maryland, in May 2019 — would increase the credit for employers with up to 25 employees to 75% of retirement plan costs from the current 50%, up to an annual cap of $5,000.

"That is a very material difference," Mr. Mason said. If an employer with 25 or fewer employers were to spend $2,000 to establish, administer and communicate a new plan, he or she would now get a $1,500 credit a year for three years instead of $1,000 under the current law, he explained.

The House bill — the Securing a Strong Retirement Act last introduced by Rep. Richard Neal, D-Mass., and Rep. Kevin Brady, R-Texas, in October 2020 — is even more generous. The legislation would cover 100% of retirement plan startup costs for employers with 50 or fewer employees, up to an annual cap of $5,000. In addition, they would receive an additional credit for contributions they make on behalf of each employee up to a cap of $1,000 for five years. The proposed credit would offset 100% of employer contributions for the first two years and then fall gradually to 75% in year three, 50% in year four and 25% in year five.

A business that contributes $1,000 to each of its 20 employees, for example, would receive a $20,000 credit for the first two years, a $15,000 credit in the third year, a $10,000 credit in the fourth year, and a $5,000 credit in the fifth year.

"That is a game-changing increase in the credit," Mr. Mason said. "If we see some combination of the House and Senate proposals, I think it would be a great step forward."