Retirement Plan Startup Credit
A small business that starts a retirement plan can claim a tax credit for up to 100% of the startup and administration costs, capped at $5,000 a year, for three years. Adding automatic enrollment earns another $500 a year for three years. A credit reduces tax dollar for dollar, so the plan's first-years cost can come close to zero.
Reviewed by Ebot Mbi, CPA, EA · Last reviewed October 9, 2026
Who it fits
- Employers with up to 100 employees, and especially those with 50 or fewer, who have not had a plan in the last three years
- Owners who want to shelter their own income in a 401(k) and need a plan anyway
- Businesses competing for staff who expect a retirement benefit
- Companies with several non-highly compensated employees, since the cap scales with them
Who it's not for
- Businesses that maintained a qualified plan for substantially the same employees in the prior three years
- Solo owners with no non-highly compensated employee, who do not qualify
- Employers unwilling to fund ongoing plan costs once the three credit years end
How it works
The credit covers ordinary and necessary costs to set up and run the plan and educate employees about it. Employers with up to 25 employees get 100% of those costs; those with 26 to 50 get 50%. Employers with 51 to 100 employees also qualify, at the 50% rate, under the base rules.
The annual cap is the greater of $500 or the lesser of $250 for each eligible non-highly compensated employee or $5,000. That means you need 20 eligible rank-and-file employees to reach the full $5,000.
The credit is available for the first year the plan is effective and the next two. You may elect to start the three years with the year before the plan's effective date.
A separate $500 credit applies for each of the first three years a plan includes an automatic enrollment feature. That credit can also apply when an existing plan adds auto-enrollment.
Employers with up to 50 employees may also qualify for a credit toward their own contributions to employee accounts in the plan's first five years, which phases down over that period. We run that calculation separately.
Illustrative example
Illustrative: a 22-employee firm, 18 of whom are eligible non-highly compensated employees, launches a 401(k) with automatic enrollment. Setup and administration costs run $6,000 a year.
- Credit rate for 25 or fewer employees: 100% of $6,000 = $6,000 of eligible cost
- Cap: lesser of $250 x 18 = $4,500 or $5,000, which is $4,500
- Startup credit each year: $4,500
- Auto-enrollment credit each year: $500
- Annual credit: $4,500 + $500 = $5,000
- Three-year total: $5,000 x 3 = $15,000
About $15,000 of tax credit over three years against $18,000 of plan costs; the $4,500 credited each year cannot also be deducted.
The rules
| Rule | Citation |
|---|---|
| Eligible small employers may claim a credit for qualified startup costs of a new plan for up to three years. | IRC §45E |
| The credit is the greater of $500 or the lesser of $250 per eligible non-highly compensated employee or $5,000, at 100% of costs for employers with up to 25 employees. | IRC §45E(b) |
| Costs used for the credit cannot also be deducted. | IRC §45E(e)(2) |
| A separate $500 credit applies for three years for plans with an automatic contribution arrangement. | IRC §45T |
| The credits are claimed on Form 8881. | IRS Form 8881 instructions |
Watch-outs
- Related businesses under common control count as one employer for the employee count and the prior-plan test.
- The credit needs at least one non-highly compensated employee who is eligible. A plan for the owner alone does not qualify.
- Don't deduct costs already used for the credit. It is a common error on the first-year return.
- Plan documents, notices and nondiscrimination testing are ongoing obligations. The credit ends; the duties do not.
What we do
We model the plan type that fits your payroll and your own savings goal, calculate the credits, and claim them on Form 8881 with your return. We coordinate with the plan provider or third-party administrator on design and testing.
Questions
Does a SEP or SIMPLE IRA qualify?
Yes. SEP and SIMPLE IRA plans are eligible plans for the startup credit, as are 401(k) plans.
What if I only have five employees?
The cap is the greater of $500 or $250 per eligible non-highly compensated employee, so with four eligible employees the cap is $1,000 a year. It still offsets a meaningful share of a low-cost plan.
Can the credit create a refund?
It is a general business credit. Unused amounts generally carry back one year and forward up to 20 years rather than refunding directly.