Salary Reduction SEPs (SARSEPs)

In regular SEP plans, the employer decides whether to make a contribution and how large it will be. In a Salary Reduction SEP (SARSEP), employees choose to have the employer contribute to their SEP-IRAs instead of paying them the equivalent amount as salary. In this respect, SARSEPs are similar to a 401(k) plan — allowing the employee to defer income that would otherwise have been received and taxed.

New SARSEPs have been prohibited since January 1, 1997. However, employers may continue to make contributions under pre-1997 rules to existing SARSEPs, and employees hired after 1996 may participate in existing SARSEPs.

The maximum annual elective deferral for a SARSEP participant is the same as for 401(k) plans and tax-sheltered annuities:

Participant 2026 Elective Deferral Limit
Under age 50 $24,500 (adjusted annually for inflation)
Age 50 or older (catch-up) $32,500 ($24,500 + $8,000 catch-up)

These limitations apply only to the amount by which an employee’s salary is reduced (i.e., the elective deferral). The regular SEP contribution rules discussed in prior pages apply separately to any additional employer contributions made to a SARSEP.

The SARSEP elective deferral limit is the same as the 401(k) limit and is adjusted annually for inflation by the IRS. The total of all contributions to a participant’s SARSEP (elective deferrals plus employer contributions) is still subject to the overall SEP limit of the lesser of 25% of compensation or $72,000 (2026).

To maintain a SARSEP, an employer must meet the following requirements:

  • The employer must have had no more than 25 eligible employees at any time during the prior year
  • At least 50% of eligible employees must choose to participate by making salary reduction contributions

If the 50% participation threshold is not met, the SARSEP fails for that year and elective deferrals must be returned to employees as taxable income. Employer contributions made under regular SEP rules are unaffected.

SIMPLE IRAs as the modern alternative: Since SARSEPs were closed to new plans in 1997, the SIMPLE IRA (Savings Incentive Match Plan for Employees) has become the standard employee-deferral option for small employers. SIMPLE IRAs are available to employers with 100 or fewer employees and allow both employee salary deferrals and employer matching or nonelective contributions. See Module 4 — SIMPLE IRAs →
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