What Is a Salary Reduction Arrangement?

A salary reduction arrangement is an arrangement under which you can elect to have your employer contribute part of your pay to your SEP-IRA. Only the remaining portion of your pay is currently taxable. The tax on the contribution is deferred. The amount contributed under the arrangement is called an elective deferral.

Limits on deferrals. In general, elective deferrals on your behalf to all retirement plans cannot be more than $10,500 for 2001 ($11,000 for 2002). This limit applies only to the amounts that represent a reduction from your salary, not to any contributions from employer funds.

For contributions made after December 31, 2001, additional elective deferrals can be contributed to your salary reduction arrangement SEP-IRA if:

• You are 50 or older, and
• No other elective deferrals can be made for you to the plan for the year because of limits or restrictions, such as the regular annual limit.

The most that can be contributed in additional elective deferrals to your salary reduction arrangement SEP-IRA is the lesser of the following two amounts.

1. $1,000 for 2002, or
2. Your compensation for the year reduced by your other elective deferrals for the year.

The additional deferrals are not subject to any other contribution limit and are not taken into account in applying other contribution limits. The additional deferrals are not subject to the nondiscrimination rules as long as all eligible participants are allowed to make them. For more information, see Publication 553, Highlights of 2001 Tax Changes.

Excess deferrals. Excess elective deferrals not withdrawn by April 15 are considered regular IRA contributions and are subject to the IRA contribution limits.

Overall limits on SEP contributions. Contributions, including elective deferrals, made by your employer to the SEP-IRA are subject to the overall limit of 15% of your compensation (generally up to $170,000 for 2001 ($200,000 for 2002)) or $35,000 for 2001 ($40,000 for 2002), whichever is less. In effect, the overall limit is $25,500 for 2001 (15% x $170,000), and is $30,000 for 2002 (15% x $200,000).

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