Salary Reduction Simplified Employee Pension Plan (SARSEP)


A SARSEP is a Simplified Employee Pension (SEP) plan that:

  • Was established before 1997.
  • Permits employee salary reduction contributions.
  • Meets the following participation requirements annually based on all eligible employees (even those hired after 1996):
    • At least 50% of eligible employees must choose to make employee salary reduction contributions for the year.
    • Had no more than 25 employees who were eligible to participate at any time during the preceding year.
  • May need to be amended for current law changes.

Participate in a SARSEP Plan 
Operate and Maintain a SARSEP Plan 
Correct SARSEP Plan Errors 
Terminate a SARSEP Plan 
Additional Resources

Participate in a SARSEP Plan

An eligible employee is an individual (including a self-employed individual) who meets all the following requirements:

  • Has reached age 21
  • Has worked for the employer in at least 3 of the last 5 years
  • Received at least $650 in compensation for 2021 from the employer during the year ($600 for 2019 and for 2020)

An employer can use less restrictive participation requirements than those listed, but not more restrictive ones.

An employer can exclude the following employees from a SEP or SARSEP:

  • Employees covered by a union agreement and whose retirement benefits were bargained for in good faith by the employees' union and the employer
  • Nonresident alien employees who do not have U.S. wages, salaries or other personal services compensation from the employer

Example 1: Employer X maintains a calendar year SEP. The eligibility requirements under the SEP are: an employee must perform service in at least three of the immediately preceding five years, reach age 21 and earn the minimum amount of compensation during the current year. Bob worked for Employer X during his summer breaks from school in 2016, 2017 and 2018, but never more than 34 days in any year. In July 2019, Bob turned 21. In August 2019, Bob began working for Employer X on a full-time basis, earning $30,000 in 2019. Bob is an eligible employee in 2019 because he has met the minimum age requirement, has worked for Employer X in three of the five preceding years and has met the minimum compensation requirement for 2019.

Example 2: Employer Y writes its SEP plan to provide for immediate participation regardless of age, service or compensation. John is age 18 and began working part-time for Employer Y in 2019. John is an eligible employee for 2019.

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Operate and Maintain a SARSEP Plan

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.

Each employee's total contribution limits are subject to annual cost-of-living-adjustments.

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 Form 5305A-SEP instructions to determine whether you meet the SARSEP DP test.

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.

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Correct SARSEP Plan Errors

Find, fix and avoid plan errors.

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Terminate a SARSEP Plan

If you decide your SARSEP no longer suits your business, consult your financial institution partner to determine if another type of retirement plan might be a better match.

To terminate a SARSEP, notify the SARSEP financial institution that you will no longer be making contributions and that you want to terminate your contract or agreement. You must also notify your employees that you have discontinued the SARSEP.

You do not need to give any notice to the IRS that the SARSEP has been terminated.

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Additional Resources