SARSEP Fix-It Guide - Overview
A SARSEP is a Salary Reduction Simplified Employee Pension plan. It’s a Simplified Employee Pension (SEP) plan set up before 1997 that permits employees to contribute through employee salary reductions, also called “employee elective deferrals.”
Under a SARSEP, employees and employers make contributions to traditional IRAs set up for eligible employees, subject to certain limits. Each employee is always 100% vested in (or, has ownership of) all money in his or her SEP-IRA.
To have a SARSEP, you:
- Must have established the SARSEP before 1997.
- Need to keep the plan amended for current law changes (see Question 1).
- Must meet the following participation requirements annually based on all eligible employees (even those hired after 1996).
- At least 50% of your employees eligible to participate must choose to make employee elective deferrals for the year.
- You must have no more than 25 employees who were eligible to participate in the SARSEP at any time during the preceding year.
Employers who established a SARSEP prior to January 1, 1997, can continue to maintain it and new employees hired after December 31, 1996, can participate in the existing SARSEP.
Formal written agreement. You must maintain a formal written agreement to provide benefits to all eligible employees under a SARSEP. You can satisfy the written agreement requirement with the IRS model SARSEP using Form 5305A-SEP, Salary Reduction Simplified Employee Pension—Individual Retirement Accounts Contribution Agreement.
Prototype SARSEPs. Financial institutions and other approved sponsoring organizations can sponsor a prototype SARSEP document. The IRS issues opinion letters approving prototypes. Plan sponsors can use individually designed documents, but the IRS doesn't have an approval process for these.
Information you must give to employees. You must give each eligible employee a copy of Form 5305A-SEP, its instructions and the other information listed in the Form 5305A-SEP instructions. If you adopted a prototype SARSEP, you must give each eligible employee similar information.
Setting up the employee’s SEP-IRA. A SEP-IRA must be set up by or for each eligible employee. SEP-IRAs can be set up with banks, insurance companies or other qualified financial institutions. You send SARSEP contributions to the financial institution where you maintain the SEP-IRA.
Who is eligible to participate?
Generally, any employee who performs services for your business must be included in your SARSEP. However, there are some exceptions to this general rule. Among the employees that you may exclude from a SARSEP are those who:
- Haven’t worked for the company during three out of the last five years.
- Haven’t reached age 21 during the year for which you make contributions.
- Are employees who are covered by a union agreement and whose retirement benefits were bargained for in good faith by you and the employees’ union.
- Are nonresident alien employees who have received no U.S. source wages, salaries or other personal services compensation from you.
- Received less than $550 in compensation (subject to cost-of-living adjustments) during the year. Generally, W-2 compensation will satisfy the definition of “compensation.”
Only employers with 25 or fewer eligible employees in the prior year can permit employee elective deferrals in the current year. If you have more than 25 eligible employees this year, but had less than 25 employees in the preceding year, employees can make elective deferrals this year. For example, if you had 23 eligible employees in 2013, but 27 eligible employees in 2014, those 27 employees may make elective deferrals to their SEP-IRAs in 2014. However, in 2015, no employee elective deferrals may be made by you or your employees.
What are the participation rules?
At least 50% of all eligible employees must make employee elective deferrals each year. If less than 50% of your eligible employees choose to make employee elective deferrals to the SARSEP for a year, all employee elective deferrals made by other eligible employees for that year are disallowed and must be withdrawn from the employees’ SEP-IRAs.
What are the contribution requirements?
By establishing a SARSEP, you’ve adopted a plan that requires a SEP-IRA to hold the contributions made for each of the eligible employees. A SARSEP is funded by money that employees elect to defer from their salaries. Employer contributions are also allowed, but only in the form of “nonelective” contributions - employer contributions made to each eligible employee’s SEP-IRA - regardless of whether, or how much, the employee deferred into the SEP-IRA. Your SARSEP plan document will specify the nonelective contributions, if any, required under the plan. The law does not permit matching contributions in a SARSEP.
Total contributions to each employee’s SEP-IRA cannot exceed the lesser of $52,000 for 2014 (subject to cost-of-living adjustments for later years) or 25% of pay. (Employee elective deferrals are subject to lower limits imposed by IRC Section 402(g) (see Question 5). Contributions made under the SARSEP - both employee elective deferrals and employer nonelective contributions - are 100% vested (or owned by) the employees. Publication 560, Retirement Plans for Small Business (SEP, SIMPLE, and Qualified Plans), has a worksheet to help self-employed individuals determine the amount of their maximum contribution.
Contributions must be in the form of money (cash, check or money order). You can’t contribute property, except in a rollover. See Publication 590-A, Contributions to Individual Retirement Arrangements (IRAs), for more information about rollovers.
After you send the SARSEP contributions to the financial institution, it will manage the funds. Depending on the financial institution, participants can invest SARSEP contributions in stocks, mutual funds and other, similar types of investments.
The financial institution/trustee handling the SEP-IRAs provides the IRS and participants with an annual statement containing contribution and fair market value information on Form 5498.
Do SARSEPs have anti-discrimination tests?
SARSEP DP test. The employee elective deferrals of your highly compensated employees (HCEs) must meet the SARSEP DP (deferral percentage) test. Under the SARSEP DP test, the amount deferred each year by each eligible HCE, as a percentage of pay (the deferral percentage), can’t be more than 125% of the deferral percentage of all eligible nonhighly compensated employees (NHCEs).
Deferral percentage. Each employee’s deferral percentage is the ratio of the employee's elective deferrals for a year divided by the employee's compensation for the same year.
You must compute the deferral percentage limitation each year. The instructions for Form 5305A-SEP have a worksheet you can use to determine whether the elective deferrals of your HCEs meet the SARSEP DP test.
Top-heavy contributions. A SARSEP is top-heavy when more than 60% of all contributions go to key employees. Many SARSEPs are written to operate as if they were always top-heavy, thereby eliminating the need to make the annual 60% determination. When a SARSEP is top-heavy, non-key employees must receive a minimum employer contribution of up to 3% of pay.
What are the basic distribution rules?
Employees can withdraw their SARSEP contributions and earnings at any time. A withdrawal is taxable in the year you receive it. If an employee makes a withdrawal before the employee is age 59½, a 10% additional tax will generally apply. Employees may roll over SARSEP contributions and earnings tax-free to other IRAs and retirement plans.
SARSEP contributions and earnings must eventually be distributed. The law requires a specific minimum amount be distributed by April 1 of the year following the year the employee reaches age 70½.
What are the filing requirements?
A SARSEP plan sponsor generally has no filing requirements. The annual reporting required for qualified plans (Form 5500 series) is normally not required for SARSEPs. The financial institution that holds the plan SEP-IRAs handles most of the other paperwork.