What is a SARSEP Plan?

A Salary Reduction Simplified Employee Pension, commonly known as a SARSEP, is a type of retirement plan that holds a unique place in the history of retirement savings options. It was designed for small businesses with 25 or fewer employees, providing them with a streamlined way to offer retirement benefits without the complexity and cost associated with traditional 401(k) plans [1] [2] [4].

The SARSEP plan was created under the Tax Reform Act of 1986, offering a straightforward and cost-effective retirement solution for small businesses [3] [5]. The key feature of a SARSEP is that it allows employees to contribute a portion of their salary on a pre-tax basis into an Individual Retirement Account (IRA). The employer may also make contributions to these accounts, further boosting the employee's retirement savings [1] [3].

However, it's important to note that SARSEPs are a legacy product. After January 1, 1997, businesses could no longer establish new SARSEP plans, though existing plans were grandfathered in and allowed to continue [2] [3]. As a result, SARSEPs have become less common over time, with many employers opting for newer retirement plans like 401(k)s or Simplified Employee Pension (SEP) IRAs [3] [4].

For employees participating in a SARSEP, contributions are made directly from their salary before taxes are deducted, which reduces their taxable income for the year [1] [3]. The funds in the SARSEP grow tax-deferred until withdrawal, typically during retirement, at which point they are taxed as ordinary income. This tax deferral is a significant benefit, as it allows the retirement savings to compound over time without the drag of annual taxes [4] [5].

Employers also have the flexibility to contribute to the SARSEP on behalf of their employees. However, contributions are subject to specific limits. For example, employee contributions cannot exceed 25% of their compensation or a maximum dollar limit set by the IRS each year. In 2024, this limit is $23,000 for employees under age 50, with an additional $7,500 catch-up contribution allowed for those 50 and older [1] [5]. Employers can also make discretionary contributions, provided they do so for all eligible employees [3] [5].

The SARSEP plan's simplicity and low administrative burden made it a popular choice for small businesses in its day. However, for those managing an existing SARSEP, it’s essential to stay compliant with IRS regulations to maintain the plan's tax-advantaged status. This includes regular reporting and ensuring contributions do not exceed the legal limits [1] [2].

In summary, a SARSEP is a retirement plan designed for small businesses that allows employees to make pre-tax contributions to an IRA, with the potential for employer contributions as well. While no new SARSEP plans can be created, existing ones continue to offer a valuable retirement savings option for those who have them [3] [4].

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References

[1] IRS. (n.d.). Salary Reduction Simplified Employee Pension Plan (SARSEP). Retrieved from https://www.irs.gov/retirement-plans/plan-sponsor/salary-reduction-simplified-employee-pension-plan-sarsep 

 [2] Investopedia. (n.d.). Salary Reduction Simplified Employee Pension Plan (SARSEP). Retrieved from https://www.investopedia.com/terms/s/sarsep.asp 

 [3] SmartAsset. (2023, February 2). What Is a SARSEP Retirement Plan? Retrieved from https://smartasset.com/retirement/sarsep 

 [4] Janus Henderson. (n.d.). Salary Reduction Simplified Employee Pension (SARSEP) IRA. Retrieved from https://www.janushenderson.com/en-us/investor/resources/planning/all-account-types/sarsep-ira/ 

 [5] Gusto Help Center. (n.d.). SARSEP. Retrieved from https://support.gusto.com/article/106622436100000/SARSEP