401(k) & SECURE Act 2.0: An Accountant's Guide to Tax Savings

In today's ever-evolving tax landscape, accountants must stay ahead of the curve to provide their clients with the best possible strategies for retirement planning. Key to this task is an in-depth understanding of 401(k) retirement plans and the updated provisions under the SECURE Act 2.0. Both of these components carry substantial tax benefits and savings potentials that, when utilized strategically, can significantly enhance a client's financial future. This guide offers an essential walk-through for accounting professionals on these two crucial topics, emphasizing how they can maximize tax incentives and better serve their clients' retirement planning needs.

Understand 401(k) Basics

A 401(k) is an employer-sponsored retirement savings plan that allows employees to save a portion of their income into an investment account, which can grow via investments until the funds are withdrawn at retirement age. 

Participating in a 401(k) has numerous advantages:

• Employees are able to set aside money from each paycheck to invest toward retirement savings. The IRS imposes limits on how much money employees are able to put into a retirement account. For 2023, the contribution limit for those contributing to a 401(k) is $22,500 (up from $20,500 in 2022). The catch-up contribution limit for employees over the age of 50 increased to $7,500, up from $6,500.
• Employers may add money to their employees’ savings with an employer matching up to a certain percentage. This allows employees to save even more toward their financial future at no cost to themselves.
• Under certain circumstances, account owners can utilize their 401(k) to receive hardships, early withdrawals, and loans for certain unexpected financial needs.
• Tax advantages for other businesses and employees.

Let’s dive further into the specific tax-related advantages of 401(k) plans.

Tax benefits of a 401(k) for employees

There are two types of 401(k) accounts: Traditional (tax-deferred) and Roth.

If you choose to utilize a Traditional 401(k), you are not required to pay income taxes on your contributions to a 401(k) account because it is tax-deferred. Your contributions are tax-exempt until withdrawal. Your employer deducts the contribution from your paycheck before it becomes subject to income tax. You are still liable to pay Federal Insurance Contributions Act (FICA) taxes for Social Security and Medicare, even if you don't pay income taxes on your 401(k) contributions. These taxes are calculated based on your total paycheck, including your 401(k) contributions.

With a Traditional 401(k), employees are not required to deduct the contributions to their 401(k) account on tax returns. Employment forms such as a W2 will deduct the amount contributed to the 401(k) from your taxable income for the year.

In the case of a Roth 401(k), the account is funded with after-tax dollars. This means the contributor pays taxes on their income and then contributes the designated amount of their net income into the account. With a Roth account, withdrawals upon retirement are tax-free.

Tax benefits of a 401(k) for employers

While the benefits (tax and otherwise) are very clear for employees, the benefits for employers may not be as well-known.

Not only is a 401(k) a great tool for recruitment and retention within businesses, but it also offers several money-saving opportunities:

• For their own corporate taxes, businesses are able to deduct employer match and profit-sharing contributions made to their employees’ 401(k) accounts. This is capped at 25% of the total compensation paid to eligible employees
• A qualifying alternative retirement plan type to satisfy the requirements of state-mandated retirement plans to avoid penalties and fines associated with noncompliance.
• Capitalize on SECURE Act 2.0 tax credit opportunities for launching a 401(k) plan after December 29, 2022. We’ll dive into this more below.

SECURE Act 2.0 tax credits

The SECURE Act 2.0 was signed into law on December 29, 2022. It is an iteration of the original SECURE (Setting Every Community Up for Retirement Enhancement) Act that was passed in 2019. Both acts have provided much-needed adjustments to the retirement system in the United States.

SECURE Act 2.0 has more than 90 provisions that work toward addressing the retirement savings gap in the country. These provisions provide several changes that promote saving earlier for retirement, provide incentives to small businesses for offering retirement plans, and add some flexibility in how people are able to save and use the money they have saved.

The updated legislation creates significant tax benefits for small businesses to start offering retirement benefits to their employees.

Doubles tax credits for new plans: small businesses with up to 50 employees are able to receive tax credits to cover 100% of plan startup costs (up from 50% with the original SECURE Act) for each of the first three years. This is capped at $5,000 per employer per year.

• Eligible businesses with 51-100 employees are eligible for tax credits equal to 50% of administrative costs for three years. This is also capped at $5,000 annually.

Auto-enrollment tax credit: Auto-enrollment requires participants to manually opt out or edit the contribution rate of their company’s 401(k) offering. Businesses that set up auto-enrollment can receive a tax credit of $500 per year for the first three years.

Added credits for employer contributions: Small businesses employing 50 or fewer people are eligible for another tax credit, which is calculated based on a percentage of employer contributions. This credit can reach up to $1,000 per employee for those earning less than $100,000 in the previous year.

Additionally, eligible employers with 51 to 100 employees can benefit from a credit phase-in that is equal to:

• A percentage of 2% points for each employee for the preceding taxable year in excess of 50 employees.
• The amount determined above, multiplied by:
  • 100% in the first and second years
  • 75% in the third year
  • 50% in the fourth year
  • 25% in the fifth year

Offering a 401(k) has always provided tax advantages for both employees and employers. But with added legislation like the SECURE Act 2.0, the time to start a 401(k) is now.

Do you have any clients looking to save on their taxes this year? Human Interest is here for you to be a resource for both you and your clients. Reach out to learn more about partnering with Human Interest.