What Is a SARSEP and How Does It Work for Employers and Employees?
Explore how SARSEP plans benefit both employers and employees with flexible contributions and tax advantages.
Employers seeking a flexible retirement plan for their small business might consider a Salary Reduction Simplified Employee Pension (SARSEP). This retirement plan benefits both employers and employees by allowing pre-tax contributions, leading to tax savings and promoting long-term financial security.
Understanding the mechanics of SARSEPs is key to maximizing these benefits.
Eligibility Requirements
To establish a SARSEP, businesses must meet specific criteria. These plans are available only to businesses with 25 or fewer eligible employees. Eligible employees include those who earned at least $750 in compensation during the previous year, including part-time and seasonal workers.
At least 50% of eligible employees must participate by making salary reduction contributions, ensuring the plan is actively utilized. Employers must also adhere to non-discrimination rules, ensuring contributions do not disproportionately benefit highly compensated employees. Additionally, the IRS’s top-heavy rules stipulate that no more than 60% of the plan’s benefits can go to key employees—those owning more than 5% of the business or earning over $215,000 annually.
Employer Contribution Guidelines
Employer contributions are a central aspect of SARSEP plans. Employers have the flexibility to decide whether to contribute each year, depending on the company’s financial situation. Contributions must follow IRS limits for SEP plans, which in 2024 are the lesser of 25% of an employee’s compensation or $66,000.
These contributions are typically made by the employer’s tax-filing deadline, including extensions, allowing for strategic planning. Employer contributions are also deductible as a business expense, providing tax savings and enhancing the plan’s appeal.
Employee Salary Reduction Arrangements
Employees can allocate a portion of their salary to the SARSEP, boosting retirement savings while lowering their taxable income. These pre-tax contributions reduce the employee’s taxable wage base. For 2024, the maximum contribution is $22,500, with an additional $7,500 allowed for those aged 50 and older.
Employers should support employees by offering resources to help them make informed decisions about contributions, particularly when balancing other financial obligations.
Tax Reporting Duties
Accurate tax reporting is essential for managing a SARSEP. Employers must report contributions using IRS Form 5498, detailing the total amount contributed to each employee’s account by May 31 of the following year.
Employees must ensure their contributions are properly recorded on their W-2 forms in Box 12, using Code F. This ensures the IRS recognizes these as pre-tax contributions, reducing the employee’s taxable income.
Distribution and Rollover Options
Understanding distribution and rollover rules is critical for SARSEP account holders. Distributions are taxed as ordinary income, and early withdrawals before age 59½ may incur a 10% penalty unless exceptions apply under IRC Section 72(t).
SARSEP funds can be rolled over into another traditional IRA, SEP IRA, or an employer-sponsored plan like a 401(k), provided the receiving plan accepts rollovers. Direct transfers avoid taxable events, while indirect rollovers must be redeposited within 60 days to prevent taxes and penalties. Employers should educate employees on these options to help them preserve their retirement savings.