Who qualifies as a Highly Compensated Employee (HCE)?
Let's be honest: hiring your first employee (or your tenth) is both thrilling and terrifying. You're growing, expanding, becoming a real business, but you're also taking on payroll, benefits, and a whole new level of responsibility. It's expensive. It's complicated. And if you're like most small business owners, you're wondering how you're going to afford competitive benefits like a retirement plan without breaking the bank.
Here's the good news: The IRS is basically offering to pay for it.
Thanks to SECURE 2.0, small businesses that start a retirement plan, especially those joining a pooled employer plan (PEP) like Castle Rock PEP, can now access tax credits worth up to $16,500 over the first few years. Think of it as the IRS extending a handshake and saying, "Welcome to the club. We've got your back."
Let's break down exactly how these credits work, who qualifies, and why this might be the smartest financial move you make this year.
The Big Three: SECURE 2.0 Tax Credits Explained
SECURE 2.0 didn't just tweak the retirement plan rules, it completely rewrote the playbook for small businesses. If you're starting a new 401(k) plan in 2024 or beyond, you're now eligible for three separate tax credits that can dramatically reduce (or even eliminate) your costs in the early years.
Here's the breakdown:
1. The Startup Costs Credit: 100% Coverage (Up to $5,000/Year for 3 Years)
Starting a retirement plan used to mean shelling out thousands in administrative and setup fees. Not anymore. Under SECURE 2.0, eligible small businesses can now claim 100% of their qualified startup costs, capped at $5,000 per year for three years. That's a potential $15,000 in savings just for getting your plan off the ground.
Qualified startup costs include things like:
- Plan design and implementation fees
- Employee education and communication materials
- Record-keeping and administrative services
If you're working with a PEP like Castle Rock, those startup costs are already streamlined and affordable, and now the IRS is picking up the tab.
Who qualifies? Businesses with 1-50 employees that haven't offered a retirement plan in the past three years.
2. The Employer Contribution Credit: Up to $1,000 Per Employee Per Year (for 5 Years!)
This is where things get really interesting. The IRS isn't just helping you start a plan, they're also helping you fund it.
For each non-highly compensated employee (NHCE) who participates in your plan, you can claim a tax credit worth up to $1,000 per year for the first five years. In years 1 and 2, you get 100% of your employer contributions back (up to that $1,000 cap per employee). In years 3-5, the credit phases down to 75%, 50%, and 25%, respectively.
Let's put that in perspective: If you have 10 employees and you contribute $1,000 per employee per year, you're looking at a $10,000 tax credit in Year 1 alone. That's real money back in your pocket.
Who qualifies? Businesses with up to 100 employees. The credit applies only to contributions made on behalf of NHCEs (employees earning less than $155,000 in 2026).
3. The Automatic Enrollment Credit: $500/Year for 3 Years
If your plan includes automatic enrollment, which is a best practice that boosts employee participation and helps you pass compliance tests, you can claim an additional $500 per year for three years. That's an extra $1,500 just for setting your plan up the right way from day one.
Total Potential Value: $5,000 (startup) + $10,000 (employer contributions for 10 employees) + $1,500 (auto-enrollment) = $16,500 in Year 1 alone.
And remember, some of these credits extend for up to five years. Over the life of the credits, you could be looking at tens of thousands of dollars in savings.
The "Power of 10" Example: Real Numbers, Real Savings
Let's make this concrete. Imagine you're a growing business with 10 non-owner employees. You decide to start a 401(k) plan with Castle Rock PEP, and you're committed to contributing $1,000 per employee per year to help them build retirement security.
Here's what your first year looks like:
- Startup/Admin Costs: $3,000 (covered 100% by the Startup Costs Credit)
- Employer Contributions: $10,000 ($1,000 × 10 employees, covered 100% by the Employer Contribution Credit in Year 1)
- Automatic Enrollment: Implemented (adds $500 credit)
Total Tax Credits in Year 1: $13,500
That means the IRS is essentially funding your entire retirement plan in the first year. You're offering a benefit that attracts and retains top talent, and it's costing you little to nothing out of pocket.
Over five years, those credits continue to add up, especially the employer contribution credit, which runs for a full five years (even as it phases down). By the time the credits end, your plan is established, your employees are saving, and you've built a foundation of loyalty and trust.
Meet Form 8881: Your New Best Friend at Tax Time
All of these credits are claimed using IRS Form 8881 (Credit for Small Employer Pension Plan Startup Costs). If you've never heard of it, don't worry, it's straightforward, and if you're working with a knowledgeable plan provider like Castle Rock PEP, we'll walk you through exactly what you need to do.
Form 8881 captures:
- Your qualified startup costs
- The number of eligible employees
- Whether your plan includes automatic enrollment
- Your employer contribution amounts
You file it with your annual business tax return, and the credit directly reduces your tax liability. It's that simple.
Pro Tip: Keep detailed records of your plan expenses and contributions throughout the year. Your plan provider (that's us!) should be able to supply the documentation you need to make filing Form 8881 a breeze.
Why Castle Rock PEP Makes This Even Easier
Here's the thing: Tax credits are great, but they don't do you much good if the process of starting and running a retirement plan is overwhelming, time-consuming, or riddled with compliance landmines.
That's where a pooled employer plan (PEP) like Castle Rock PEP comes in.
When you join a PEP:
- We handle the administration. No need to become a retirement plan expert overnight. We take care of the compliance, reporting, and fiduciary heavy lifting.
- You reduce costs. By pooling resources with other small businesses, you get access to institutional-level pricing and investment options, without the institutional-level headaches.
- You stay focused on your business. Your job is to grow your company and take care of your team. Our job is to make sure your retirement plan runs smoothly, stays compliant, and maximizes those tax credits.
Plus, because we specialize in serving small businesses, we understand the unique challenges you face. We're not just checking boxes, we're building a partnership designed to support your long-term success.
Hiring Is a Milestone, And the IRS Is Helping You Celebrate
Let's zoom out for a second. Hiring employees is one of the most significant milestones in your business journey. It means you're no longer a solo show, you're building a team, a culture, a legacy. And with that comes responsibility.
Your employees aren't just looking for a paycheck. They're looking for stability, opportunity, and a sense that you're invested in their future. Offering a retirement plan sends a powerful message: I see you. I value you. I'm committed to helping you build a secure future.
And now, thanks to SECURE 2.0, the IRS is making it financially feasible, even profitable, to do the right thing.
Your Next Steps: Don't Leave Money (or Talent) on the Table
If you're a small business owner with at least one non-owner employee, you owe it to yourself, and your team, to explore these tax credits. Here's how to get started:
- Review your eligibility. Do you have 1-100 employees? Have you not offered a retirement plan in the past three years? If yes, you're likely eligible.
- Estimate your potential credits. Use the "Power of 10" example as a starting point. How many employees do you have? What would a reasonable employer contribution look like? Run the numbers.
- Reach out to Castle Rock PEP. We'll help you design a plan that works for your business, maximizes your tax credits, and sets your employees up for long-term success. Let's start the conversation.
- File Form 8881 at tax time. With the right documentation (which we'll help you gather), claiming your credits is straightforward.
The Bottom Line
Hiring employees is expensive. Benefits are expensive. But thanks to SECURE 2.0, starting a retirement plan doesn't have to be.
With up to $16,500 in tax credits available in the first year alone: and benefits that extend for up to five years: there's never been a better time to offer your team a 401(k) plan. And with Castle Rock PEP handling the details, you can focus on what you do best: running your business.
The IRS is extending a handshake. All you have to do is reach out and take it.
Simplifying retirement for all. One plan. Every business.
Ready to explore how much you could save? Contact us today or learn more about why joining a PEP makes sense for small businesses like yours.
