SARSEP Plan (Salary Reduction Simplified Employee Pension)

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What Are SARSEP Plans?

Salary Reduction Simplified Employee Pension (SARSEP plans):

A SARSEP is a SEP set up before 1997.

Before 1997 an employee could choose (elect) to have an employer contribute part of his/her pay to a SEP-IRA. This contribution is called an elective deferral.
- Deferral means, income taxes on the portion of the employee's wages contributed to his/her SEP-IRA remain untaxed until they are eventually distributed to the employee.
After 1996, SARSEPs could no longer be established.
- However, if an employer maintained a SARSEP before 1997 the employer may continue to maintain it and employees hired after 1996 may choose to enroll in it.
Participants in a SARSEP set up before 1997 can continue to have the employer contribute part of their pay to the plan.
Employees hired after 1996 who enroll in a previously established SARSEP may also have part of their pay contributed to the plan.

Form W-2 Reporting for SARSEPs:

Salary reduction contributions are not subject to federal income tax.
- Do not include SARSEP contributions in the Wages, tips, other comp. box on Form W-2.
However, salary reduction contributions are subject to social security and Medicare taxes.
- Include an employee's gross wages (which must include his/her SEP-IRA contributions) on Form W-2, in the boxes for:
- Social security wages, and
- Medicare wages.
Salary reduction contributions are also subject to Federal Unemployment Taxes (FUTA).

Contribution Limits:

May contribute the lesser of 25% of each employee’s compensation or $49,000 in 2011 (for 2012 the contribution limit will be the lesser of 25% of each employee's compensation or $50,000).

Employee elective deferrals cannot exceed $16,500 for 2011 (or $22,000 if age 50 or over in 2011).

Catch-up Contributions for SARSEPs:

Subject to certain limits, for tax year 2011, a participant age 50 or over at the end of the calendar year can contribute an additional $5,500.

Who Cannot Have a SARSEP?

If you haven’t already chosen and established a SARSEP, you can’t choose one now.

That’s because a change in law prohibited new SARSEPs from being established after 1996. Also, a state or local government, any of its political subdivisions, agencies, or instrumentalities, or a tax-exempt organization cannot have a SARSEP.

By establishing a SARSEP, you, the employer, have adopted a plan that requires an IRA to hold the contributions made on behalf of each of your employees. A SARSEP is designed to be funded mainly by money that employees elect to defer from their salaries.

Employer “nonelective contributions” are also allowed. Employer nonelective contributions are employer contributions made to each eligible employee’s SEP-IRA - regardless of whether or how much the employee deferred into the SEP-IRA.

Total contributions to each employee’s SEP-IRA cannot exceed the lesser of $49,000 for 2011 or 25% of pay.

Each employee is always 100% vested in (or, has ownership of) all contributions - both employee elective deferrals and employer nonelective contributions - in his or her SEP-IRA.

Publication 560 helps self-employed individuals determine the amount of their maximum deduction.

To Establish a SARSEP, You...

Must have established the plan before 1997.
Have 25 or fewer eligible employees in the preceding year.
Use Form 5305A-SEP or adopt a prototype or individually designed SARSEP plan document.

Who Contributes:

Employee and employer contributions allowed.

Filing Requirements:

An employer generally has no filing requirements. The annual reporting required for qualified plans (Form 5500 series) is normally not required for SARSEPs. The financial institution handles most of the paperwork.

Notice Requirements:

Employees must receive notice of the adoption of a SARSEP, any subsequent amendment to it, the requirements for receiving contributions, and the amounts of excess deferrals if the ADP test was not satisfied (see SARSEP ADP Test.

Participant Loans:

Not permitted.

In-Service Withdrawals:

Permitted, but includible in income and subject to a 10% additional tax if under age 59 1/2.

Pros and Cons:

Easy to set up and operate - usually just a phone call to a financial institution gets things started.
Administrative costs are low.
Plan does not have fixed contribution requirements - a good plan if cash flow is an issue.
Discrimination rules apply. These rules are in place to see that contributions don’t discriminate in favor of highly compensated employees (when compared to contributions for non-highly compensated employees).

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