Types of Retirement Accounts: SARSEP

Retirement. It’s something that most of us don’t think we need to worry about until we get older. Retirement is also something that most of us don’t think we can worry about right now. After all, we have student loans, expensive healthcare costs, rising housing prices, kid’s college, aging parents, and a host of other financial worries that usually push the idea of retirement to the back of our mind. Additionally, retirement can be overwhelming. Most people have no idea what to invest in, how the investing process works, what tax implications our decisions may have, and most of all; how much money do you need to retire. So let’s check out the SARSEP.

While all of these questions will be answered in future articles, this article will start on the ground floor with the question: What are the different types of retirement plans? There are several different types of retirement plans and in this article, we will be addressing #7: Salary Reduction Simplified Employee Pension Plan (SARSEPs). These articles will give you an idea of what to look for when deciding on how to save for retirement and what type(s) of retirement accounts to save in.

Types of Retirement Plans

1. Traditional IRA
2. Roth IRA
3. 401(k)
4. 403(b)
5. SIMPLE IRA
6. Simplified Employee Pension (SEP)
7. Salary Reduction Simplified Employee Pension Plan (SARSEP) (this article)
8. Payroll Deduction IRA
9. Profit-Sharing Plan
10. Defined Benefit Plan
11. Money Purchase Plan
12. Employee Stock Ownership Plan (ESOP)
13. Thrift Savings Plan (TSP)
14. 457 Plan

IMPORTANT: READ THIS BEFORE CONTINUING

Before we get into the types of retirement accounts, it is important to make one key distinction. A retirement account, itself, is not an investment. If you say something to the extent of, “My 401(k) hasn’t done very well this past year and I’m thinking of picking a different one” you would be making an incorrect statement.

Think of it like this: There are 14 different types of retirement accounts (we will discuss the other 13 in different articles). Each one of those retirement accounts should be thought of as a cooking pot. If you cook something in that pot and you don’t like what it tastes like, you don’t dump the contents into another pot and hope that it tastes better. You change the ingredients of that pot to something else. Now think of the ingredients as different investment products (stocks, bonds, cash, mutual funds, and/or a host of other products/ingredients).To get the taste you want, you change the ingredients, not the pot. You may be wondering, what ingredients do I put into my pot? That is a fair question, but you cannot answer that question until you figure out what pot is best for you. Now buckle up and find out what the 14 different types of retirement accounts (pots) you have at your disposal.

Credit: Nicholas Gras: https://unsplash.com/@armgd

(7) Salary Reduction Simplified Employee Pension Plan (SARSEP)

A Salary Reduction Simplified Employee Pension Plan (hereafter referred to as a SARSEP) is a type of retirement plan that is meant for self employed individuals but it can also be used for employees of small businesses (but this is unusual). 

For all intents and purposes, a SARSEP is the same as a SEP. Think of a SARSEP as an older version of a SEP. According to the IRS, there are a few key differences.

• A SARSEP is for businesses established before 1997.
• A SARSEP allows for salary reduction contributions for employees.
• A SARSEP meets meets the following participation requirements based on all eligible employees (even if hired before 1997):
  • At least 50% of eligible employees must choose to make salary reduction contributions during the current year.
  • Have no more than 25 eligible employees who could participate during the previous year.

Now that we’ve gone over what the differences are between a SARSEP and a SEP, let’s go over the ins and outs of a SARSEP.

Within a SARSEP you can have many different investments such as:

1. Stocks
2. Bonds
3. Mutual funds
4. Unit investment trusts
5. Government securities (Treasury bills, treasury notes, and treasury bonds)
6. US government-issued gold and silver coins. 

If you don’t know what all of these different terms mean, that is perfectly fine. Just know that you can have nearly all investment within an SARSEP.

But, there are a few items that cannot be in an SARSEP. SARSEPs cannot have:

1. Antiques
2. Gems
3. Rare coins
4. Works of art
5. Life insurance contracts: This is because life insurance contracts are not securities (investments).
6. Municipal bonds: This is because putting a municipal bond in a SARSEP would negate the tax free status of the municipal bond.

Antiques, gems, rare coins, and works of art cannot be included in a SARSEP because these items do not have a solid market value. Meaning: I might be willing to pay $50,000 for a painting, but you may be willing to only pay $3,000 for the same painting. It is too difficult to find an agreeable market value.

There are some stipulations to having an SARSEP that are important to know.

1. Contribution Limits (as of 2021): This is possibly the most important difference between a SARSEP and an IRA. With an IRA, you can contribute a maximum of $7,000 per year to it. With a SARSEP, you can contribute the lesser of $57,000 or 25% of your total compensation. Keep in mind that the word compensation refers to your income after expenses. 
2. Contribution Deductions (as of 2021):There are a few differences with how you can deduct your SARSEP contributions that can get a little complicated and are outside the scope of this article. But just know that you may not be able to deduct your SARSEP contributions as you would IRA contributions.
3. Early Withdrawal (as of 2021): You should never take money out of a SARSEP until you are at least 59 ½. This is the most important consideration of a SARSEP (and any retirement account for that matter). This money is not there for you to buy a boat or go on a vacation, it is to retire with. If you take money out of a SARSEP before age 59 ½ you will pay taxes and a penalty of 10%. For example, if you are single and make $50,000/year and want to withdraw $10,000 from a SARSEP, you will be taxed 22% ($2,200) + 10% penalty ($1,000). You will only come home with $6,800 (even though you withdrew $10,000) after taxes and the penalty. However, there are a few exceptions to the early withdrawal rule.

1. Death: Your heirs can take the money, not you, you’re dead.
2. Disability: If you become permanently disabled, you can withdraw from your SARSEP without penalty (although you will still have to pay the appropriate taxes).
3. Home purchase: You can withdraw up to $10,000 from a SARSEP for the purchase of your first home (primary residence) without penalty (although you will still have to pay the appropriate taxes).
4. Higher education expenses: This would be paying for college, community college, or technical school for yourself, your spouse, your child, or grandchild. 
5. Medial premiums during unemployment: You can withdraw the amount of health insurance premiums during the time that you are unemployed without penalty (although you will still have to pay the appropriate taxes.)
6. Unreimbursed medical expenses: You can withdraw the amount needed to pay any medical expenses that have not (and likely will not) be reimbursed by another party without penalty. But once again, you will still have to pay taxes on this amount.
7. Qualified disaster distributions: If you receive “substantially equal periodic payments” when you have been the victim of a qualified disaster you will not be subject to the 10% penalty so long as the distributions do not exceed $100,000.

4. Required Minimum Distributions (as of 2021): You will have to start taking the money out when you turn 70 ½.. This is called a Required Minimum Distribution (or RMD for short). The amount that you have to take out each year starting at 70 ½ (or more precisely, by April 1st of the year following the year you reach 70 ½) is outside the scope of this article. Just know that when you turn 70 ½, even if you don’t need the money, you will be required to take out some of it each year. To find out the exact amount, talk to your CPA or a financial advisor and they would be happy to help.
5. Employee Contribution: This is another big difference between a SARSEP and an IRA.Employees don’t usually contribute to a SARSEP. As I discussed earlier, SARSEPs are usually for self employed individuals. However, in the case of a SARSEP, if the employer wants to establish a SARSEP, the employer must contribute the same percentage of pay to the employee’s SARSEP as they do to their own. So let’s look at the example of Paul who is a business owner and his employee, Burt. Paul makes $100,000 per year and Burt makes $30,000 per year. If Paul wants to contribute to a SEP at the rate of 20%, he would contribute $20,000 to his own SARSEP and he would also have to contribute $6,000 to Burt’s SARSEP. Anthony does not put any of this money in himself. Only the employer, Paul. Here’s a chart to better see how it works.

	Paul (employer)	Burt (employee)
Income	$100,000	$30,000
Contribution (20%)	$20,000	$6,000

6. Spousal SARSEP: There is no Spousal SARSEP. To have a SARSEP, you must be either self employed, an employer, or an employee. Once again, this is a big difference between the offerings of a SARSEP and an IRA. 
7. ROTH SARSEP: There is no ROTH option of a SARSEP. There are several different options to consider when opening up a retirement account. This is a big one. All monies put into a SARSEP will be before tax. This means that you do not pay taxes on the money up front. You wait and pay taxes on the money when you take it out at retirement. There are ways that this can be rolled into a Roth IRA, but that is outside the scope of this article.

As you can probably see, there are some major differences between a SARSEP and an IRA (or any other retirement for that matter). But here are the important differences:

• Contribution limits are the lesser of $57,000 or 25% of your compensation (as of 2021) rather than $6,000 or $7,000 that you would be able to put into an IRA.
• You cannot deduct the amount that you put into a SARSEP like you can the amount that you put into an IRA.
• If you have employees, having a SARSEP can get really expensive really fast because you have to match the percentage that you put into your SARSEP into their SARSEP.
• There is no spousal IRA.
• There is no Roth version of a SARSEP.

SARSEPs certainly don’t apply to everyone. In fact, unless you have a business and/or have been self-employed since before 1997, a SARSEP won’t apply to you at all. But if you are ever a contestant on Jeopardy you can hopefully give the question to the answer of “The retirement account version that predates a Simplified Employee Pension”.

I hope that you now understand SARSEPs a little bit better and have grown your Money Muscle. Until next time!