The first time I encountered a SARSEP was with a long-established small professional services firm that had adopted the salary reduction arrangement back in the early 1990s. The owner was still running it as though it were a standard SEP – not realizing that the 50% employee participation rule still applied and that their SARSEP status could be jeopardized if that rule was violated. Grandfathered plans need active monitoring, not just annual contributions.
Key Takeaways
- Form 5305-A-SEP is the IRS model agreement for a Salary Reduction Simplified Employee Pension (SARSEP) – a plan type that allowed employees to reduce their salaries and have those amounts contributed to SEP-IRAs on a pre-tax basis.
- No new SARSEPs have been permitted since January 1, 1997 – Small Business Job Protection Act of 1996 closed SARSEPs to new adoption. Only plans established before 1997 can continue operating as SARSEPs; new employees hired by grandfathered employers can still participate.
- For existing SARSEPs, the employee salary reduction deferral limit for 2025 is $23,500 ($31,000 with age-50 catch-up), subject to the 25% of compensation limit.
- SARSEPs have a 50% employee participation requirement: at least 50% of eligible employees must elect to participate in the salary reduction arrangement each year. Failing this test disqualifies the salary reduction feature.
- Employer contributions to the SEP portion (non-salary reduction) can also be made to SARSEP accounts under the same SEP rules – up to the lesser of 25% of compensation or $70,000 (2025).
- Quick rule for your SOP: for any SARSEP client, verify at year-end that the 50% participation test is met before reporting salary reductions as excludable from income.
What Form 5305-A-SEP Is and When to Use It
Form 5305-A-SEP, Salary Reduction Simplified Employee Pension – Individual Retirement Accounts Contribution Agreement, is the IRS model plan agreement that established the legal framework for a SARSEP. It governs the relationship between the employer, employees, and the SEP-IRA accounts that hold the contributions. Like other 5305-series forms, it is not filed with the IRS but is retained by the employer as the plan document.
The critical context: SARSEPs were a simplified alternative to 401(k) plans for small employers, allowing employees to defer a portion of their salary pre-tax into SEP-IRA accounts without the complexity and administrative cost of a full 401(k). The Small Business Job Protection Act of 1996 eliminated the ability to establish new SARSEPs starting January 1, 1997, replacing them with SIMPLE IRAs and expanded SIMPLE 401(k) options. However, SARSEPs established before that date were grandfathered – they can continue to operate, and new employees hired after 1996 by an existing SARSEP employer are eligible to participate.
Who Can Still Use a SARSEP
An employer can continue using a SARSEP if – and only if – the plan was established before January 1, 1997, using Form 5305-A-SEP or equivalent approved plan language. Employers who meet that historical threshold can continue making both employee salary reduction contributions and employer SEP contributions under the grandfathered plan. New employers, and employers who allowed a prior SARSEP to lapse or be terminated, cannot establish a new SARSEP – they must use a SIMPLE IRA or SIMPLE 401(k) instead.
SARSEP vs. SEP-IRA vs. SIMPLE IRA
The SARSEP combined features of both a SEP (employer contributes to IRA accounts) and a 401(k)-like salary reduction arrangement. The modern SIMPLE IRA is the closest equivalent for new small employer plans – it allows employee elective deferrals and requires employer matching or nonelective contributions. Standard SEP-IRAs do not allow employee salary reduction; only employer contributions are permitted. If a client operates a SARSEP, they have the most feature-rich of these three options – which is exactly why eligible employers are motivated to continue the grandfathered plan.
How to Complete Form 5305-A-SEP
The model form establishes the terms of the SARSEP, including which employees are eligible, the salary reduction election procedures, contribution limits, and the 50% participation test mechanics. Most of the plan terms are prescribed by the IRS; the employer fills in identifying information and executes the agreement.
| Article / Section | Content | Key Points |
|---|---|---|
| Employer identification | Employer name, EIN, plan year, effective date | Must show pre-1997 establishment date for grandfathered status |
| Eligibility requirements | Employee participation criteria: age, service, minimum compensation | SEP eligibility: age 21, at least 3 of the past 5 years, earned at least $750 (2025 threshold) from employer |
| Salary reduction election | Employee election procedure and timing | Election must be made before the compensation is paid; cannot be retroactive |
| Deferral limitation | Annual elective deferral cap | Lesser of annual 402(g) limit ($23,500 for 2025) or 25% of compensation |
| 50% participation test | Minimum participation requirement | At least 50% of eligible employees must make an election each year; failure disqualifies salary reduction feature for the year |
| Employer SEP contributions | Optional employer contributions in addition to salary reductions | Same SEP rules apply: nondiscrimination, same percentage of compensation for all eligible employees |
| IRA accounts | Both salary reductions and employer contributions deposited to individual SEP-IRA accounts | Each participating employee must have a SEP-IRA; funds are immediately vested and portable |
The 50% Participation Test in Practice
The 50% participation test requires that at least half of all eligible employees elect to participate in the salary reduction arrangement each year. This can be tricky in small businesses where the total eligible workforce fluctuates. If only 4 of 10 eligible employees make a salary reduction election, the test fails for that year – the employer must treat the elected deferrals as regular compensation (includable in income) rather than pre-tax reductions. The employer contributions to SEP-IRAs can still be made, but the salary reduction feature is effectively suspended for that year.
Deadlines, Penalties, and Filing Requirements
| Requirement | Deadline | Notes |
|---|---|---|
| SARSEP salary reduction election | Before compensation is paid | Must be a prospective election; retroactive salary reduction elections are not permitted |
| SARSEP contributions to SEP-IRAs | Due date of employer’s tax return (including extensions) | Same deadline as regular SEP contributions |
| Employee elective deferral limit (2025) | $23,500 ($31,000 age 50+) | Subject also to 25% of compensation limit; whichever is lower |
| Total SEP contribution limit (2025) | $70,000 | Combined employer + employee salary reductions cannot exceed this amount |
| 50% participation test | Must be met annually | Failure in any year means salary reductions for that year are not excludable |
| Form 5498 (annual contribution reporting) | Trustee files by May 31 | Reports contributions, rollovers, and FMV for each SEP-IRA account holder |
No Form 5500 Required
One administrative advantage of a SARSEP is that it generally does not require filing Form 5500 (Annual Return/Report of Employee Benefit Plan). SEP plans, including SARSEPs, are exempt from most ERISA plan reporting requirements that apply to 401(k) plans. This means significantly lower administrative burden – no annual return to the Department of Labor, no plan audit requirements for most employers. The employer’s primary compliance obligations are maintaining the plan document, verifying the 50% test annually, and ensuring contributions are deposited timely.
SARSEP Compliance and Grandfathering Rules
A grandfathered SARSEP can continue indefinitely as long as the employer maintains the plan and continues to meet the participation and contribution requirements. There is no deadline by which existing SARSEPs must be converted to another plan type. However, the practical issue is that plan sponsors and participants sometimes lose awareness of the specific SARSEP rules – particularly the 50% test – over time, especially as the original advisors who set up the plan move on.
For CPAs advising SARSEP employers, I recommend an annual SARSEP compliance checklist as part of the tax return engagement. The checklist should confirm that the plan was established before 1997, that the 50% participation test was met, that elective deferrals did not exceed the applicable limit, and that employer contributions (if any) were made on a nondiscriminatory basis. Small errors create big cleanup if a SARSEP is later determined to have been disqualified – all contributions for disqualified years would be includable in employees’ income.
Converting a SARSEP to a SIMPLE IRA
An employer with a grandfathered SARSEP may decide to simplify by terminating the SARSEP and establishing a SIMPLE IRA instead. This is a legitimate planning option, particularly for employers who want more consistent treatment and SIMPLE IRA matching contribution flexibility. The transition requires proper notice to employees, a plan termination process, and confirmation that the former SARSEP accounts are properly maintained as regular SEP-IRAs going forward. SARSEP termination is a one-way door – once terminated, the SARSEP cannot be re-established.
SARSEP vs. SIMPLE IRA – Employer Comparison
For the small number of employers still operating grandfathered SARSEPs, understanding the comparison to SIMPLE IRAs is valuable for planning conversations. The SARSEP often wins on contribution limits (the elective deferral limit for SARSEPs follows the 402(g) limit, which equals the 401(k) limit), while SIMPLE IRA limits are lower. The SIMPLE IRA wins on administrative simplicity and does not have a 50% participation test.
| Feature | SARSEP (Grandfathered) | SIMPLE IRA (New Adoption) |
|---|---|---|
| New adoption permitted? | No – pre-1997 only | Yes |
| Employee elective deferral (2025) | $23,500 ($31,000 age 50+) | $16,500 ($20,000 age 50+, $17,600 ages 60–63 under SECURE 2.0) |
| Employer size limit | 25 or fewer employees at adoption | 100 or fewer employees |
| 50% participation test | Yes – must be met annually | No |
| Employer contribution requirement | None required (optional SEP contributions) | Required: 2% nonelective or 3% matching |
| Form 5500 required? | Generally no | Generally no |
Common Mistakes That Slow Things Down
- Treating a SARSEP as a standard SEP – SARSEPs have the additional 50% employee participation test that standard SEPs do not. Ignoring this test and allowing salary reductions to proceed without verifying participation can result in those deferrals being includable in employee income for the year.
- Assuming a SARSEP can still be established – no new SARSEPs have been permitted since 1997. An employer who comes to you wanting a “salary reduction SEP” needs a SIMPLE IRA or SIMPLE 401(k), not a SARSEP.
- Not verifying grandfathered status – before advising on an ongoing SARSEP, confirm that the original plan was established before January 1, 1997. If the plan document is undated or was adopted after that date, the SARSEP may not be valid.
- Allowing retroactive salary reduction elections – SARSEP elections must be prospective – the employee elects before the compensation is earned. Retroactive elections are not permitted and do not create a valid salary reduction.
- Confusing SARSEP deferral limits with SIMPLE IRA limits – SARSEP elective deferrals follow the 402(g) limit (same as 401(k)), which is significantly higher than the SIMPLE IRA limit. Applying the SIMPLE IRA limit to a SARSEP understates the maximum contribution.
- Not providing the disclosure to new employees – when new employees become eligible to participate in a SARSEP, they must receive specific information about the plan including the eligibility requirements, the salary reduction election process, and the current year’s contribution limits. Failure to provide the required disclosure creates compliance risk.
Practical Checklists You Can Reuse
Copy these into your internal wiki or SOP.
Annual SARSEP Compliance Checklist
- Confirm plan was established before January 1, 1997 (verify plan document date)
- Identify all eligible employees (age 21+, 3 of 5 prior years, at least $750 compensation from employer in 2025)
- Verify that at least 50% of eligible employees made a salary reduction election for the year
- Confirm that no employee’s elective deferral exceeded $23,500 (or $31,000 for age 50+)
- Confirm that no employee’s elective deferral exceeded 25% of their compensation
- Confirm that total contributions (employer + salary reduction) do not exceed the SEP limit ($70,000 for 2025)
- Verify that employer contributions, if any, were made on a nondiscriminatory basis (same percentage for all eligible employees)
- Confirm that contributions were deposited by the employer’s tax return due date
Employee Onboarding Checklist – New SARSEP Participants
- Confirm the new employee meets eligibility requirements (age, years of service, minimum compensation)
- Provide the required SARSEP disclosure document to the new employee
- Obtain the employee’s salary reduction election form (prospective – applies only to compensation not yet earned)
- Establish a SEP-IRA account for the new participant or confirm an existing IRA can serve as the receptacle
- Track the new employee’s participation for the annual 50% participation count
For Accounting Firms – Keep Delivery Smooth While You Scale
SARSEP clients represent a specialized compliance niche – the rules are narrow, the grandfathering is time-limited to pre-1997 plans, and the annual participation test creates ongoing monitoring obligations that many firms underestimate. Offshore staff trained on retirement plan compliance can handle the annual checklist verification, contribution limit calculations, and nondiscrimination confirmations that SARSEP clients require, leaving senior staff to focus on planning and advisory conversations.
Accountably supports CPA and EA firms with retirement plan compliance workflows for small business clients. We keep this mention brief on purpose, your process comes first.
FAQs About Form 5305-A-SEP
Can I still establish a SARSEP for my business?
No. The Small Business Job Protection Act of 1996 closed SARSEPs to new adoption effective January 1, 1997. No new SARSEPs can be established. If you want a plan that allows employee salary deferrals, the equivalent modern option is a SIMPLE IRA (for employers with 100 or fewer employees) or a SIMPLE 401(k). Existing SARSEPs established before 1997 can continue to operate.
What is the 50% participation test for a SARSEP?
The 50% participation test requires that at least half of all eligible employees make a salary reduction election each year. If fewer than 50% elect to participate, the salary reduction feature fails for that year – the amounts employees elected to defer must be treated as regular compensation, includable in income. Employer SEP contributions can still be made, but the salary reduction feature is effectively suspended. The test must be re-evaluated each year.
What is the maximum employee salary reduction contribution to a SARSEP in 2025?
For 2025, the maximum elective deferral to a SARSEP is $23,500 ($31,000 for participants age 50 or older), subject to the additional limit of 25% of the employee’s compensation. The 25% limit is often the binding constraint for lower-income employees. These limits follow the same structure as 401(k) elective deferral limits – not the lower SIMPLE IRA limits.
Do I need to file Form 5500 for a SARSEP?
Generally no. SEP plans, including SARSEPs, are exempt from most ERISA Form 5500 filing requirements that apply to 401(k) plans. This is one of the administrative advantages of maintaining a SARSEP versus transitioning to a SIMPLE 401(k). The employer’s primary compliance obligations are maintaining the plan document, verifying the 50% test annually, and ensuring timely contributions.
What happens if I terminate my SARSEP?
Once terminated, a SARSEP cannot be re-established. The SEP-IRA accounts continue to exist as regular IRA accounts for each participant – the funds remain accessible subject to normal IRA distribution rules. If the employer wants to continue offering retirement benefits, they would need to establish a new plan type (SIMPLE IRA, SEP-IRA without salary reduction, or a qualified plan). Termination requires proper notice to employees and should be documented.
This article is educational, not tax advice. Rules change, and states differ. Confirm thresholds, deadlines, and elections against the current IRS instructions for your year and facts.