If you haven’t already established a SARSEP, you can’t choose one now because a law change prohibited new SARSEPs from being established after 1996. Employers who established SARSEPs prior to January 1, 1997, can continue to maintain them and new employees of the employers hired after December 31, 1996, can participate in the existing SARSEPs. The introduction of SIMPLE IRA plans under Internal Revenue Code Section 408(b) (added to the Code by SBJPA) is intended to fill the need for retirement plans like SARSEPs. States or local governments, any of their political subdivisions, agencies or instrumentalities, or tax-exempt organizations cannot have a SARSEP.
Who is eligible for participation?
Generally, any employee who performs services for your business in three out of the last five years must be included in the SARSEP. There are some exceptions. The SARSEP Fix-It Guide explains the participation rules. This guide contains valuable information on avoiding common problems in operating a SARSEP.
What are the contribution rules?
SARSEPs require an IRA to hold the contributions made for each of your eligible employees. A SARSEP is funded by:
- Employee elective deferrals (also referred to as salary reduction contributions) and
- Nonelective employer contributions - employer contributions made to each eligible employee’s SEP-IRA - regardless of how much the employee deferred.
See the SARSEP Fix-It Guide for additional information on the contribution rules and other information on avoiding common problems in operating a SARSEP.
Participation Test: At least 50% of all eligible employees must make elective deferrals each year. If fewer than 50% of these employees choose to make elective deferrals, all employee elective deferrals for that year must be withdrawn from the employees’ SEP-IRAs.
SARSEP DP Test: The employee elective deferrals of highly compensated employees must meet the SARSEP Deferral Percentage test, in which the amount each eligible highly compensated employee defers each year, as a percentage of pay (the deferral percentage), cannot be more than 125% of the DP of all eligible non-highly compensated employees.
You must compute the DP limitation each year. Use the worksheet contained in the
Top-Heavy Contributions: A SARSEP is top-heavy when more than 60% of all contributions go to key employees. SARSEP plan documents are often drafted to operate as if they were always top-heavy, thereby eliminating the need to make the annual determination. When a SARSEP is top-heavy, non-key employees must receive a minimum employer contribution of up to 3% of pay. The SARSEP Fix-It Guide contains the top-heavy contribution rules and information on avoiding common problems in operating a SARSEP.
What are the basic distribution/withdrawal rules?
SARSEP contributions and earnings can be withdrawn at any time, subject to the general limitations imposed on traditional IRAs. A withdrawal is taxable in the year received. If an employee makes a withdrawal before age 59½, generally a 10% additional tax applies. SARSEP contributions and earnings may be rolled over tax-free to other IRAs and retirement plans.
SARSEP contributions and earnings must eventually be distributed following the IRA required minimum distribution rules.
Participant Loans are not permitted.
What are the filing and notice requirements?
Filing Requirements: An employer generally has no filing requirements, including the Form 5500 return.
Notice requirements: Employers must provide employees:
- a copy of the Form 5305A-SEP (or the prototype document) and the other documents and disclosures listed in its instructions.
- notice of:
- any amendments to the SARSEP
- the requirements for receiving contributions
- the amounts of excess deferrals if the DP test was not satisfied.
- an annual contribution statement.
How can I tell if my plan is operating within the rules?
You should conduct an annual check-up to help determine whether your SARSEP plan is operating within the rules. Checklists and tips are available to help with periodic reviews of your plan.
What do I do if I make a mistake in operating my plan?
Generally, if the SARSEP fails to satisfy the requirements for SARSEPs, tax benefits can be lost. However, any error can likely be corrected by using one of the IRS correction programs.
Pub 4407, SARSEP Key Issues and Assistance
Pub 4336, SARSEP Plans for Small Businesses
SARSEP Fix-It Guide, Common Problems, Real Solutions
SARSEP Frequently Asked Questions