What is a Starter 401(k) Plan?

Effective for plan years beginning after December 31, 2023, the Starter 401(k) Plan is a deferral only arrangement maintained by an eligible sponsor not already sponsoring a qualified retirement plan. Under the Starter 401(k) plan, each eligible employee who opts to participate, is required to automatically enroll at a deferral rate of 3% of compensation and no more than 15% of compensation. The annual deferral increase required is 1% each year, up to a cap of 15%.

The employer is permitted to impose certain eligibility requirements, and all employees must be eligible to participate if they meet the requirements.

The maximum annual deferral is $6,000. Catch-up contributions of $1,000 for those age 50 or older are permitted.

What is the benefit of a Starter 401(k) Plan?

Under the provisions of a Starter 401(k) Plan:

• There are no actual deferral percentage (ADP) testing requirements.
• There are no top-heavy compliance testing requirements. This will effectively reduce the compliance and cost burden for employers.
• Employer contributions are not permitted to the Plan, thus, also reducing record keeping costs for employers.
• The Plan is defined as a qualified employer-sponsored retirement plan and the Employer may qualify for up to $5,000 in tax credits over a plan’s first three years for the ordinary and necessary costs of starting the Plan.
• Automatic enrollment requirement of eligible employees increases employee participation. Employees are permitted to opt out if they so choose.
• The Employer, regardless of the number of employees, can offer a Starter 401(k) Plan.

Key Considerations

When SECURE 2.0 was signed and enacted in December of 2022, the Individual Retirement Account (IRA) contribution limit was $6,000 for individuals under the age of 50. The Starter 401(k) Plan, which became effective in 2024, has a deferral limit set at $6,000. The IRA contribution limit has been increased for cost-of-living adjustments and inflation over time, however, the Starter 401(k) plan limit remains unchanged.

From an employee standpoint, the lower contribution limit coupled with no employer matching or profit-sharing contributions hinders retirement savings growth potential. The good news is that there has been draft legislation that is expected to address this notable error and provide clarification.

The Starter Plan provides the opportunity for small businesses to offer retirement savings to their employees in a cost-effective way with less administrative barriers. Before implementing a plan, it is important to understand the different 401(k) options, such as a starter plan, safe harbor plan and traditional plan and the eligibility requirements and contribution limits under each type to assess what is best for your company and employees.