What a SARSEP is
A SARSEP is a SEP IRA that includes a salary reduction feature, allowing employees to defer part of their compensation into the plan on a pre-tax basis. Congress created SARSEPs as a simpler alternative to 401(k) plans for small employers. In 1996, Congress replaced SARSEPs with SIMPLE IRAs and closed the door to new plans. Existing SARSEPs were grandfathered — they can continue indefinitely, and new employees at the same employer can still participate.
The plan has a useful dual structure. The employer can make discretionary contributions like a standard SEP, and employees can defer part of their salary like a 401(k). But the plan must pass an annual deferral percentage test to ensure that highly compensated employees are not saving disproportionately more than rank-and-file staff. That test is the ongoing compliance burden that most SARSEP sponsors forget about.
If you inherited a SARSEP when you bought a business or took over a practice, the first question is whether the plan is still passing its tests. The second question is whether a different plan type would serve you better. Both questions are worth answering.
The deferral percentage test works as follows: the average deferral percentage of highly compensated employees cannot exceed one hundred twenty-five percent of the average for non-highly compensated employees. As workforce demographics change — high earners staying while lower-paid employees turn over, or lower participation among entry-level staff — the test becomes harder to pass without limiting owner contributions. Employers who have never modeled the test against their current payroll data may be surprised by what they find.
There is also a participation threshold embedded in the SARSEP rules. At least fifty percent of eligible employees must elect to participate for the plan to remain compliant. For small firms where a handful of employees simply never enrolled or lost interest over time, this threshold can become a quiet compliance problem. An employer with eight eligible employees needs at least four of them actively participating. If attrition or disengagement has reduced participation below that floor, the employer faces either a corrective contribution obligation or a plan that technically does not satisfy the requirements.
Investment options inside a SARSEP are held in individual IRA accounts, which means employees — and employers making discretionary contributions — are not limited to a plan menu. Each participant can direct their own IRA to a custodian of their choice and invest in whatever that custodian offers. This flexibility is one of the features that kept grandfathered SARSEPs running long after newer plan types became available. But it also means that contribution amounts flow to many different institutions, which makes recordkeeping and compliance tracking more complex than a single-platform 401(k).
What working with us looks like
First meeting — the plan audit
We meet in person and review your existing SARSEP: the contribution levels, the test results, the fee structure, and the investment options. We bring a side-by-side comparison of what a SIMPLE IRA, SIMPLE 401(k), or traditional 401(k) would look like for the same workforce.
Second meeting — the written recommendation
You leave with a written recommendation: keep the SARSEP or replace it, and if replacing, which plan type and which provider. The recommendation includes a transition timeline and a cost comparison. The plan is yours to keep whether or not you work with us.
A note on fit
When this might not be right for you
A SARSEP review is not for every employer. Some situations where this does not apply:
- Employers who established their plan after 1996. Your plan is not a SARSEP — it is either a SEP IRA or something else.
- Employers who are satisfied with their plan and have never failed the deferral percentage test. There may be nothing to change.
- Anyone looking for a firm that will sell them a replacement plan product. We advise on plan design — we do not sell products.
If you have a SARSEP and are not sure whether it still makes sense, one meeting will answer the question.
Frequently asked questions
What is a SARSEP plan?
A SARSEP is a grandfathered SEP IRA that includes a salary reduction feature allowing employees to defer part of their pay on a pre-tax basis. No new SARSEPs can be established after 1996, but existing plans can continue operating indefinitely.
Can I still contribute to a SARSEP?
Yes. Existing SARSEPs can continue to accept both employer and employee contributions. New employees at the same employer can also participate. The plan must continue to pass the annual deferral percentage test.
What is the SARSEP deferral percentage test?
The deferral percentage test compares the contribution rates of highly compensated employees to those of non-highly compensated employees. If the gap is too large, the test fails and excess contributions must be returned. This is the same type of test that applies to traditional 401(k) plans without a safe harbor.
Should I replace my SARSEP with a 401(k)?
It depends on whether the SARSEP is still serving your workforce well. If the deferral percentage test is becoming hard to pass, if you want a Roth option, or if contribution limits are too restrictive, a 401(k) with safe harbor or a SIMPLE 401(k) may be a better fit. A 401(k) with a safe harbor provision eliminates nondiscrimination testing entirely, which is the primary advantage the SARSEP once offered through its dual-contribution structure. When employees are already contributing near their caps and the safe harbor cost is manageable, the replacement often pays for itself in reduced compliance headaches and higher owner contributions. We compare the options using your actual payroll data.
What happens to a SARSEP if the business is sold?
If the business changes ownership, the new owner can continue the SARSEP as long as the plan structure remains intact. However, the new owner cannot establish a new SARSEP — only maintain the existing one. A change in ownership is a good time to evaluate whether a different plan type would work better. If the successor business already has a retirement plan of its own, integrating the SARSEP participants may require a plan amendment or termination. The compliance steps at acquisition are specific enough that the new owner should review the plan with an ERISA-familiar advisor before the ink dries on the purchase.
Do you charge a commission to replace a SARSEP?
No. We are fee-only fiduciaries. We advise on whether to keep or replace the plan and, if replacing, which plan type fits best. We accept no commissions, referral fees, or compensation from any plan provider.