What Is a SARSEP Plan?
A SARSEP is a salary reduction plan that allows small businesses to make contributions on behalf of their employees. It is a pre-1997 simplified employee pension (SEP) plan that involves a salary reduction mechanism.
Employees can elect to have their employer contribute a portion of their wages to an Individual Retirement Account or Annuity (IRA) established under the SARSEP (a SEP-IRA). After 1996, a SARSEP could not be formed.
However, for SARSEPs established before 1997, eligible workers hired after 1996 must be permitted to participate.
SARSEP plans, like SIMPLE IRAs, are intended for small enterprises with less than 100 employees. Despite their limited advantages, these plans are still employed by certain small enterprises.
SARSEP Requirements
Two sorts of documentation were necessary to establish a SARSEP. The SARSEP plan itself, as well as the SEP-IRA account for each SARSEP participant.
A SARSEP plan was developed using either IRS Form 5305A-SEP or an IRS-approved prototype SARSEP. SEP-IRAs are established for each employee with banks, insurance companies, or other qualifying financial institutions using IRS Form 5305 PDF, Form 5305-A PDF, or an IRS-approved prototype IRA.
Below is more information about the other forms that need to be filed in connection to SARSEPs.
Form 5500
Unlike other eligible retirement plans, SARSEPs are not required to file Form 5500, Annual Return/Report of Employee Benefit Plan.
SARSEPs are exempt from the Department of Labor's reporting and disclosure requirements if the employer meets certain employee notification criteria and does not place investment limits on funds donated to workers' SEP-IRAs.
Form W-2 Reporting
Do not include employees' voluntary deferrals in the Wages, tips, and other remuneration boxes. However, they must be included in the Social Security and Medicare wage and tip boxes.
Box 12 must also include them. Box 13 must have the Retirement plan box ticked.
General Reporting Obligations
In addition to the above-mentioned employee notification criteria, the bank, insurance company, or other trustee or issuer of SEP-IRAs must meet the following general reporting requirements:
1. To record contributions to a SEP-IRA, the trustee or issuer must file Form 5498, IRA Contribution Information, with the IRS. Each SARSEP participant must submit a separate Form 5498.
Participants must also be given this form or another statement of fair market value and account activity.
2. Form 1099-R, Payouts From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, and Other Financial Instruments, is used to record SEP-IRA distributions.
Payouts from a SEP-IRA are subject to the same withholding requirements as regular IRA distributions.
Who Can Participate?
An eligible employee is a person (including a self-employed person) who satisfies all of the following requirements:
- Has attained the age of 21
- Has spent at least three of the past five years working for the firm
- During the year, received at least $650 in pay from the company for 2022 or $750 in pay for 2023.
Employers may impose less stringent participation requirements than those mentioned, but not more stringent ones.
The following employees may be excluded from a SEP or SARSEP by their employer:
- Employees who are covered by a collective bargaining agreement whose retirement benefits were negotiated in good faith by the employees' union and the employer
- Employees who are nonresident foreigners who do not receive wages, salaries, or another recompense for personal services in the United States
Contribution Limits
The annual contribution ceiling is $20,500 in 2022, with a catch-up provision allowing individuals over 50 to contribute an extra $6,500 in 2022. In 2023, the contribution limit is $22,500, with a catch-up contribution of $7,500.
Employers may make SEP contributions that cannot exceed 25% of the employee's salary or $61,000 in 2022 ($66,000 in 2023).
Plan Termination
If you feel that your SARSEP is no longer a good fit for your company, talk to your financial institution partner to see if another retirement plan might be a better fit.
To end a SARSEP, tell the SARSEP financial institution that you will no longer be contributing and that you wish to terminate your contract or agreement. You must also advise your staff that the SARSEP has been stopped.
You are not required to notify the IRS that the SARSEP has been discontinued.
Advantages of SARSEP Plans
The advantages of a SARSEP include the following:
SARSEP plans provide tax advantages. They are tax-deferred financial instruments, which means you do not have to pay taxes on the income generated by the account. You will only be required to pay taxes once you begin withdrawing funds beyond the age of 59 1/2.
For small firms that established SARSEP accounts before 1996, such retirement funds may be less expensive to manage than a standard 401(k) or a SIMPLE IRA, as the cost to open a SARSEP account was nearly nothing in 1991, but 401(k)s cost $5,000 and above.
SARSEPS are flexible. Employers can tailor their contributions to employees based on each worker's salary and years of service.
Disadvantages of SARSEP Plans
The disadvantages of a SARSEP include the following:
The most significant disadvantage of a SARSEP is that employers can only use it with 25 or fewer employees. If your business has more than 25 employees, you will not be able to set up a SARSEP.
Another disadvantage of a SARSEP is that it is a bit more complicated to set up and maintain than other retirement plans, such as a SIMPLE IRA. This is because a SARSEP must be established as a profit-sharing plan, which means there are more rules and regulations that need to be followed.
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Key Takeaways
SARSEP is a retirement savings plan that allows small businesses with 25 or fewer employees to make contributions on behalf of their workers.
SARSEP plans offer tax advantages but are more complicated to set up than other retirement savings plans.
FAQs
1. What is a SARSEP?
It is a retirement savings plan that allows small businesses with 25 or fewer employees to make contributions on behalf of their workers.
2. What are the benefits of a SARSEP?
SARSEP plans provide tax advantages. They are tax-deferred financial instruments, which means you do not have to pay taxes on the income generated by the account. You are only required to pay taxes once you begin withdrawing money beyond the age of 59 1/2.
3. What are the disadvantages of a SARSEP?
The most significant disadvantage of a SARSEP is that employers can only use it with 25 or fewer employees. A SARSEP cannot be set up if your company has more than 25 employees.
4. How do I set up a SARSEP?
SARSEP accounts must be established as a profit-sharing plan, which means more rules and regulations must be followed. You must work with a financial institution to set up the account.
5. How do I terminate a SARSEP?
To end a SARSEP, tell the SARSEP financial institution that you will no longer be contributing and that you wish to end your contract or agreement. You must also advise your staff that the SARSEP has been stopped.
