SARSEP

Salary Reduction Simplified Employee 

Pension Plan for Small Businesses

Tax Exempt & Government Entities

EMPLOYEE PLANS

Publication 4336 (Rev. 12-2017) Catalog Number 38511C Department of the Treasury Internal Revenue Service www.irs.gov
Contents

What is a SARSEP? .................................................................................................................1

Choosing a SARSEP ...............................................................................................................1

Establishing a SARSEP ...........................................................................................................1

Operating a SARSEP .............................................................................................................1

Maintaining Your Plan Document ..................................................................................1

Who Must Be Included in Your SARSEP? .....................................................................2

Contributions to Your SARSEP ......................................................................................3

Communicating With Employees ...................................................................................8

Reporting to the Government ........................................................................................9

Terminating a SARSEP ............................................................................................................9

Correction Programs ......................................................................................................9

Resources .............................................................................................................................10

Forms and Publications................................................................................................10

Customer Assistance ...................................................................................................10
1

What is a SARSEP?

A SARSEP is a simplified employee pension (SEP) plan set up before 1997 that permits 

employees to make contributions through employee salary reductions. Under a SARSEP, 

employees can choose to have the employer contribute part of their pay to their separate 

individual retirement arrangements (IRAs), referred to as SEP-IRAs. This contribution is called 

an “employee elective deferral” because employees choose (elect) to set aside the money, 

and they defer the tax on it until it is distributed to them. Another term used to describe these 

contributions is “salary reduction contributions.”

In other words, employees decide whether, and to what extent, money will be paid to IRAs 

established for them under the SARSEP, rather than money paid to them as compensation. 

SARSEPs are similar in some respects to 401(k) cash or deferred arrangements.

A SARSEP is a written arrangement (a plan) that allows an employer to make contributions 

toward its employees’ retirement without becoming involved in more complex retirement plans. 

A self-employed individual may also maintain a SARSEP. Under a SARSEP, SEP-IRAs are set up 

for each eligible employee and contributions are made to the traditional SEP-IRAs - not Roth or 

SIMPLE IRAs - of the plan participants.

Choosing a SARSEP

The Small Business Job Protection Act of 1996 (SBJPA) prospectively repealed SARSEPs. 

Therefore, employers could not establish new SARSEPs after December 31, 1996. However, 

employers who established SARSEPs prior to January 1, 1997, can continue to maintain them, 

and new employees of the employer hired after December 31, 1996, can participate in the 

existing SARSEP. The introduction of SIMPLE IRA plans under Internal Revenue Code Section 

408(p) (added to the IRC by SBJPA) was intended to fill the need for retirement plans like 

SARSEPs.

Establishing a SARSEP

Although employers cannot establish new SARSEPs after 1996, employees hired after 1996 may 

participate in existing SARSEPs. IRAs need to be established for each new participant with a 

bank, insurance company or other qualified financial institution. 

Furthermore, employers may need to amend existing plans for current law changes as discussed 

below. 

Operating a SARSEP 

Maintaining Your Plan Document

A SARSEP must be part of a written arrangement. As with regular SEPs, SARSEPs can be 

maintained by adopting a model form, a prototype document or an individually designed 

document. Form 5305A-SEP, Salary Reduction Simplified Employee Pension—Individual 

Retirement Accounts Contribution Agreement, is the model SARSEP issued by the Internal 

Revenue Service. 

Occasionally, new laws change the requirements for SARSEPs. To maintain tax-advantaged 

status and benefit under these new provisions, SARSEP plans must be amended for current law. 

Employers with model SARSEPs can do this by adopting the current version of the model Form 
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5305A-SEP. The administrator of an amended SARSEP must furnish each participant with a 

copy of the amendment and an explanation of its effects within 30 days of the amendment. 

Who Must Be Included in Your SARSEP?

All eligible employees must be allowed to participate in a SARSEP. An eligible employee is any 

employee who: 

 is at least 21 years old, and 

 has performed “service” for you in at least 3 of the immediately preceding 5 years. Service 

means any work performed for any period of time, however short. 

Less restrictive eligibility requirements can be established, but not more restrictive ones.

If you are a member of an affiliated service group, a controlled group of corporations, or trades 

or businesses under common control, service includes any work performed for any period of 

time for any other member of the group, trades or businesses.

You do not have to cover the following employees under your SARSEP: 

 employees covered by a collective bargaining agreement whose retirement benefits were 

bargained for in good faith by you and their union, 

 nonresident alien employees who did not earn U.S. source income from you, and 

 employees who received less than $600 for 2018 (subject to future cost-of-living adjustments) in 

compensation during the year. 

Example 1: Employer X maintains a calendar year SARSEP. Under the SARSEP, an employee 

must perform service in at least 3 of the immediately preceding 5 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 2013, 2014 and 2015, but never more than 34 days 

in any year. In July 2016, Bob turned 21. In August 2016, Bob began working for Employer X 

full-time earning $30,000 a year. Bob is an eligible employee in 2016 because he has met the 

minimum age requirement, has worked for Employer X in 3 of the 5 preceding years and has met 

the minimum compensation requirement for 2016.

Example 2: Employer Y designs its SARSEP to provide for immediate participation regardless 

of age, service or compensation. John is age 18 and begins working part-time for Employer Y in 

2016. John is an eligible employee for 2016. 

Note: The term “employee” includes a self-employed individual who has earned income. 

Enrolling Employees in Your SARSEP Plan

Set Up a SEP-IRA for Each Employee—A SEP-IRA must be set up by, or for, each eligible 

employee. SEP-IRAs may be set up with banks, insurance companies or other qualified financial 

institutions.

Give Employees Information—If you use Form 5305A-SEP, you must give your employees 

a copy of the form and its instructions. The model SARSEP is not considered “adopted” until 

each eligible employee is provided these documents and other information as described under 

Communicating With Employees later in this publication. If you use a prototype or individually 

designed plan, you must give all eligible employees similar information.
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25-Employee Rule

Employees cannot make employee elective deferrals to a SARSEP for a year if there were more 

than 25 employees eligible to participate at any time during the preceding year. 

The 25-employee rule is a look-back rule, and it is a year-by-year rule. For example, if you had 

23 eligible employees in 2015, but 27 eligible employees in 2016, employee elective deferrals 

may be made to the SEP-IRAs of the 27 employees for 2016. However, in 2017, no employee 

elective deferrals may be made for you and your employees.

50-Percent or More of All Eligible Employees Rule

At least 50 percent of your eligible employees must choose to make employee elective deferrals 

each year. This is a year-by-year rule.

What if less than 50 percent of your eligible employees choose to make employee elective 

deferrals?

Any year the 50-percent rule is not met, all employee elective deferrals made for that year 

are disallowed and must be withdrawn from the employees’ SEP-IRAs. You must notify each 

affected employee within 2 1/2 months after the plan year of: 

1) the amount of disallowed deferrals to his or her SEP-IRA for the preceding year, 

2) the year the disallowed deferrals and earnings are includible in gross income, 

3) information stating that the employee must withdraw the disallowed deferrals (and earnings) 

by April 15 following the calendar year of notification, and

4) an explanation of the tax consequences if the employee does not withdraw the amounts. 

See the Instructions for Form 5305A-SEP for detailed information on disallowed deferrals for 

SARSEPs maintained on a calendar-year basis.

Contributions to Your SARSEP

Overall Limits on SARSEP Contributions

Employee elective deferrals, when combined with nonelective employer contributions for any 

participant, cannot exceed the lesser of 25 percent of the employee’s compensation or $55,000 

for 2018 (subject to future cost-of-living adjustments). For calculating the 25-percent limit, 

compensation does not include employee elective deferrals to a SARSEP or other amounts 

deferred in certain other employee benefit plans. Catch-up employee elective deferrals are not 

subject to the 25-percent limit. Contributions to other defined contribution (401(k), 403(b), profitsharing or money purchase pension) plans including other SEPs, may be required to be taken 

into account for purposes of these limits.

Employer Contributions

In addition to the employee elective deferrals, you may make additional contributions to a 

SARSEP, referred to as “employer nonelective contributions.” Generally, you do not have to make 

these contributions every year unless your plan is top-heavy. See Top-Heavy Requirements

later in this publication. If you make additional contributions (other than top-heavy contributions), 

you must contribute them to the SEP-IRAs of all eligible employees who actually performed 

services during the year for which the contributions are made, even employees who die or 

terminate employment before the contributions are made.
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Contributions may not be made in such a manner as to discriminate in favor of highly 

compensated employees. Contributions are not considered discriminatory if they bear a uniform 

relationship to participants’ compensation that does not exceed $275,000 in 2018 (subject to 

future cost-of-living adjustments).

You must follow the definition of compensation stated in the plan document in the operation of 

the plan. An employee’s compensation generally includes the pay the employee received from 

you for personal services for the year. 

There are special rules for self-employed individuals. When figuring the deduction for 

contributions made to your own SEP-IRA, compensation is the net earnings from selfemployment, which takes into account both the following deductions: 1) the deduction for onehalf of the self-employment tax; and 2) the deduction for contributions to the self-employed 

individual’s own SEP-IRA. For more information on the deduction limitations for self-employed 

individuals, see IRS Publication 560, Retirement Plans for Small Business (SEP, SIMPLE, and 

Qualified Plans).

Employee Elective Deferrals

How much can be deferred? 

The most an employee can choose to defer for the 2018 calendar year is the lesser of: 

1) 25 percent of the employee’s compensation (limited to $275,000), or

2) $18,500 (IRC Section 401(g) limit).

The compensation limit in 1) of $275,000 and the amount in 2) are subject to future cost-ofliving adjustments. For a definition of compensation as it applies to this limit, refer to your plan 

document.

The $18,500 limit applies to the total employee elective deferrals the employee makes for the 

calendar year with all employers under any arrangement allowing for elective deferrals including 

401(k) and SIMPLE IRA plans. 

Additional “catch-up” elective deferral contributions are allowed for employees who have 

reached age 50. Catch-up contributions are limited to $6,000 for 2018 and subject to cost-ofliving adjustments in later years.

If an employee makes elective deferrals in excess of the Section 402(g) limit, above, the 

employee must withdraw the excess deferrals, adjusted for earnings through the end of the year, 

by April 15 of the year following the calendar year in which the excess deferrals occurred. The 

excess amount is included in gross income for the year the excess occurred. The earnings on 

the excess amount are included in income in the year distributed. 

The Deferral Percentage (DP) Test

The amount each highly compensated employee (HCE) may defer is limited. 

An HCE is an employee who:

 owned more than 5 percent of your business at any time during the year or the preceding year, or

 for the preceding year, received compensation from you of more than $120,000 in 2018 (subject 

to cost-of-living adjustments in later years) and, if specified in your SARSEP plan document, was 

in the top 20 percent of employees when ranked by compensation.

The DP test for a SARSEP compares the deferral percentage of each HCE with the average of 

the deferral percentages of all eligible nonhighly compensated employees (NHCEs). 
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The DP test must be performed each year. The deferral percentage limit for your HCEs is 

computed by first averaging the deferral percentages for the NHCEs for the year and then 

multiplying this result by 1.25. See the Instructions for Form 5305A-SEP for this computation.

Elective deferrals of HCEs that are more than the amount permitted under the DP test are excess 

contributions. Excess contributions (and earnings) must be withdrawn from the employees’ SEPIRAs. You must notify each HCE within 2 1/2 months after the end of the plan year of:

1) the amount of excess contributions to the employee’s SEP-IRA for the preceding year, 

2) the year the excess contributions and earnings are includible in gross income, 

3) information stating that the employee must withdraw the excess contributions (and earnings) 

by April 15 following the calendar year of notification, and

4) an explanation of the tax consequences if the employee does not withdraw the amounts. 

See the Instructions for Form 5305A-SEP for detailed information on correcting excess 

contributions for SARSEPs maintained on a calendar-year basis. If you do not notify your 

employees within 2 1/2 months after the end of the plan year of the excess contributions that 

must be withdrawn, you are subject to a 10-percent tax on these excess contributions. 

The excess contributions and earnings are includible in the employee’s gross income in the year 

they are distributed. However, if an employee’s excess contributions (not including earnings) are 

less than $100, they are includible in gross income in the year of notification. Earnings on excess 

contributions are included in gross income in the year they are withdrawn from the employee’s 

SEP-IRA. For example, if excess contributions occur in calendar year 2016, and the employer 

provides notification on March 1, 2017, the excess contributions must be withdrawn by April 15, 

2018. If an employee withdraws excess contributions (and earnings) from his or her SEP-IRA on 

April 1, 2018, the excess contributions must be reported as taxable income for 2016. Earnings on 

the excess contributions must be reported as taxable income for 2018.

Excess contributions not withdrawn by April 15 following the calendar year of notification may 

be considered excess contributions to the employee’s IRA. Employees may be subject to a 

6-percent excise tax on these excess contributions. In addition, if the employee is not 59 1/2 

years of age or over, the employee may be subject to an additional 10-percent tax on early 

distributions.

Example: Corporation ABC maintains a SARSEP with a calendar-year plan year. Corporation ABC 

employs two eligible HCEs (Sue and Joe) and two eligible NHCEs (Mary and Jane) with the following 

compensation and employee elective deferrals:

Participant Compensation Employee Elective 

Deferrals

Deferral Rate Average Deferral 

Percentage (ADP)

HCE 1 (Sue) $100,000 $10,000 10%

HCE 2 (Joe) $ 90,000 $ 2,700 3%

NHCE 1 (Mary) $ 10,000 $ 200 2%

NHCE 2 (Jane) $ 20,000 $ 800 4%

NHCE ADP 3%

The NHCE average deferral percentage is 3 percent (2% + 4% = 6%; 6%/2 = 3%). Therefore, the 

most that an HCE can defer is 3% x 1.25 = 3.75%.

Based on the ADP of the NHCEs, Joe passes and no correction needs to be implemented for 

him. However, since Sue is only allowed to defer 3.75 percent of her compensation or $3,750, 
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the amount of $6,250 ($10,000 - $3,750) is considered an excess contribution. Therefore, 

the employer must notify Sue by March 15 that the excess of $6,250 plus earnings has to be 

distributed from her SEP-IRA.

Top-Heavy Requirements 

A SARSEP is top-heavy for a year when more than 60 percent of all employer contributions, 

including employee elective deferrals, go to key employees as determined at the end of the 

preceding year. Many SARSEPs are drafted to operate as if they were always top-heavy, thereby 

eliminating the need to make the annual 60-percent determination. 

You will satisfy the top-heavy requirements by making a minimum contribution each year to the 

SEP-IRA of each employee eligible to participate in the SARSEP. This minimum contribution 

is not required for key employees. This contribution, in combination with other nonelective 

contributions, is equal to the lesser of:

 3 percent of each eligible non-key employee’s compensation, or 

 the percentage of compensation at which elective (not including catch-up elective deferral 

contributions) and nonelective contributions are made under this SARSEP (and any other SEP 

you maintain) for the year for the key employee with the highest percentage for the year.

Employee elective deferrals may not be used to satisfy the minimum contribution requirements 

for top-heavy plans. For purposes of determining the top-heavy minimum contribution, all 

employee elective deferrals made by key employees must be counted, but no employee elective 

deferrals made by non-key employees are counted toward satisfying the minimum contribution.

A key employee is any employee who, at any time during the preceding year was:

 an officer of the employer with compensation greater than $175,000 for 2018 (subject to cost-ofliving adjustments in later years);

 a 5-percent owner of the employer, as defined in IRC Section 416(i)(1)(B)(i); or

 a 1-percent owner of the employer with compensation greater than $150,000.

Example: Below are the employee deferrals under the XYZ Corporation SARSEP. The plan year 

ends on December 31 and employee elective deferrals are the only contributions made to the 

plan. Jane is the president of XYZ and is the 100-percent owner of the company. She is a key 

employee. She started the company and the SARSEP in 1996. During this time, she has had 

only two employees, Bill and Ted, neither of whom are officers nor own any percentage of the 

company. Therefore, they are non-key employees. Is the plan top-heavy for 2009?

Year Jane

Employee Deferral

Bill 

Employee Deferral

Ted

Employee Deferral

1996-2002 $49,000 $10,500 $10,500

2003 $7,000 $1,500 $1,500

2004 $7,000 $1,500 $1,500

2005 $7,000 $1,500 $1,500

2006 $7,000 $1,500 $1,500

2007 $7,000 $1,500 $1,500

2008 $7,000 $1,500 $1,500

Total $91,000 $19,500 $19,500
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The answer is yes. The total of the key employee elective deferrals of $91,000 when considered 

in relation to the total employee elective deferrals of $130,000 ($91,000 + $19,500 + $19,500) 

represents $91,000/$130,000, or 70 percent of the total employee elective deferrals made from 

1996-2008. Therefore, the key employee exceeds the 60-percent threshold as of the last day of 

the preceding plan year (December 31, 2008), and the plan is top-heavy for 2009.

Depositing and Investing Plan Contributions

Employer nonelective contributions must be made by the due date (including extensions) for 

filing the business’s federal income tax return for the year. 

You must forward the employee elective deferrals to the financial institution as soon as they can 

be reasonably segregated from the general assets, but in no event later than 15 days following 

the month they were withheld from the employee’s paycheck. 

Note: A Department of Labor rule provides a safe harbor period for plans with fewer than 100 

participants. If the employee elective deferrals are deposited with the plan no later than the 

7th business day following withholding by the employer, they will be considered contributed in 

compliance with the law.

After SARSEP plan contributions are sent to the financial institution where the SEP-IRAs are 

maintained, that institution will invest the funds. SEP-IRAs can be invested in stocks, bonds, 

mutual funds and similar types of investments.

At least once a year, the financial institution provides each participating employee with a 

statement showing the contributions and earnings to his or her account. Contributions are 

always immediately 100-percent vested—that is, contributions and all earnings cannot be 

forfeited.

Deducting Contributions

If your SARSEP is maintained on a calendar-year basis, you deduct contributions made for a 

year on your tax return for the year with or within which the calendar year ends. If you file your 

tax return and maintain the SARSEP using a fiscal year, you deduct contributions made for a 

year on your tax return for that year.

Example: You are a fiscal year taxpayer whose tax year ends June 30. You maintain a SARSEP 

on a calendar-year basis. You deduct SARSEP contributions made for calendar year 2017 on 

your tax return for the tax year ending June 30, 2018.

Deduct the contributions you make for your common-law employees on your business tax 

return. For example, sole proprietors deduct them on Schedule C (Form 1040), Profit or Loss 

From Business, or Schedule F (Form 1040), Profit or Loss From Farming; partnerships deduct 

them on Form 1065, U.S. Return of Partnership Income; and corporations deduct them on Form 

1120, U.S. Corporation Income Tax Return, Form 1120-A, U.S. Corporation Short-Form Income 

Tax Return, or Form 1120S, U.S. Income Tax Return for an S Corporation.

Sole proprietors and partners deduct contributions for themselves on Form 1040, U.S. Individual 

Income Tax Return. (If you are a partner, contributions for you are shown on the Schedule K-1 

(Form 1065), Partner’s Share of Income, Credits, Deductions, etc., you get from the partnership.)
8

Tax Treatment for Employees

Employer nonelective contributions are not subject to federal income tax withholding, Social 

Security, Medicare and federal unemployment (FUTA) taxes. Employee elective deferrals are 

not subject to federal income tax withholding, but are subject to Social Security, Medicare and 

federal unemployment (FUTA) taxes. 

Distributions

Participants cannot take loans from their SEP-IRAs.

SARSEP contributions and earnings can be withdrawn at any time. When participants take a 

distribution, they typically can elect to:

 take a lump sum distribution of their account, or

 roll over their account to another IRA or another employer’s retirement plan.

Distributions from a SEP-IRA are generally subject to income tax for the year in which they 

are received. If a participant takes a withdrawal from a SEP-IRA before age 59 1/2, generally a 

10-percent additional tax applies.

SEP-IRA assets may be rolled over tax-free into a traditional IRA, 401(k) (or other plan qualified 

under IRC Section 401(a)), a 403(b) plan or a governmental 457 plan. They may also be rolled 

into a Roth IRA (a transaction usually referred to as a “conversion”). Remember, amounts rolled 

over from a SEP-IRA, upon which no income tax has been paid, to a Roth IRA, will be subject 

to income tax. For additional information, see Publication 590-B, Distributions from Individual 

Retirement Arrangements (IRAs).

A specific minimum amount of SEP-IRA contributions and earnings is required to be distributed 

by April 1 of the year following the year the participant reaches age 70 1/2. Also, in this year, 

and each year thereafter, the participant must receive a required minimum distribution by 

December 31 of that year. 

Communicating With Employees

There are key disclosure documents that keep participants informed about the basics of how the 

plan operates, any changes in the plan’s structure and operations and that provide participants 

with a chance to make decisions and take timely action with respect to their accounts.

First, you provide employees with the most recent copy of Form 5305A-SEP (if this model 

form is used to establish the SARSEP plan), along with the financial institution’s procedures for 

withdrawals and transfers. This form includes:

1) A statement that IRAs, other than the one the employer contributes to, may provide different 

rates of return and contain different terms.

2) A statement that the administrator—usually the employer—of the SARSEP will provide a copy 

of any amendments within 30 days of the effective date along with a written explanation of its 

effects.

If you use a prototype or individually designed plan, you must make certain that all eligible 

employees receive similar information.

In addition, every year the trustee will give written notification to the participant of any employer 

contributions made to a participant’s IRA by January 31 of the following year on a Form 5498, 

IRA Contribution Information.
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Reporting to the Government

Employers are generally NOT required to file annual financial reports for SARSEPs.

Distributions from IRAs established under the plan are reported by the financial institution making 

the distribution to both the IRS and the recipients of the distributions on Form 1099-R, Distributions 

From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc.

The financial institution/trustee handling the SEP-IRAs provides the IRS and participants with an 

annual statement containing contribution and fair market value information on Form 5498.

Terminating a SARSEP

If the time comes when a SARSEP no longer suits the purposes of the business, consult with a 

financial institution partner to determine if another type of retirement plan might better suit the 

needs of the business.

To terminate a SARSEP, notify the financial institution handling the SEP-IRAs that contributions 

will no longer be made and that the contract or agreement is being terminated. 

Upon termination, the account of each participant retains the characteristics of a traditional IRA 

and is subject to the rules and provisions of IRA accounts.

No notice to the IRS that the SARSEP has been terminated is required.

Correction Programs

The IRS has a comprehensive system of correction programs for sponsors of retirement plans 

that are intended to satisfy the requirements—but have failed—of the Internal Revenue Code.

The Employee Plans Compliance Resolution System (EPCRS) permits plan sponsors to correct 

retirement plan failures and thereby continue to enjoy tax-favored status for their retirement 

plans. EPCRS also allows employees to continue accruing retirement benefits on a tax-favored 

basis.

Under EPCRS, employers can:

 self-correct insignificant failures, or

 apply to the IRS for correction of certain other failures under the Voluntary Correction Program. 

This application involves the payment of a fee, and the IRS will provide a written approval of the 

correction method.

See Correcting Plan Errors for details on the correction program that allows you to maintain the 

tax-favored status of your SARSEP.
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Resources

For the most up-to-date resources regarding your SARSEP or other IRA-based plans, visit 

www.irs.gov/retirement and click on Choosing a retirement plan. 

Forms and Publications

 Form 5305A-SEP, Salary Reduction Simplified Employee Pension—Individual Retirement 

Accounts Contribution Agreement

 Publication 560, Retirement Plans for Small Business (SEP, SIMPLE, and Qualified Plans)

 Publication 590-A, Contributions to Individual Retirement Arrangements (IRAs)

 Publication 590-B, Distributions from Individual Retirement Arrangements (IRAs)

 Publication 3998, Choosing a Retirement Solution for Your Small Business

 Publication 4286, SARSEP Checklist 

 Publication 4407, SARSEP: Key Issues and Assistance 

Other resources 

 SARSEP Plan Fix-It Guide - Tips on how to find, fix and avoid common mistakes in SARSEP 

plans.

 FAQs regarding SARSEPs 

 Cost-of-Living Adjustments. Annual dollar limitations on benefits and contributions.

Customer Assistance

If you need more specific guidance or have questions, you can reach us by any of the following 

methods:

 Tax Exempt and Government Entities 

Customer Account Services

P.O. Box 2508

Cincinnati, OH 45201

 877-829-5500

 www.irs.gov/retirement

 Visit Employee Plans Customer Account Services

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