As we know, there are a variety of retirement plans available to self-employed persons. The Keogh plan is among them. A Keogh plan is pronounced KEE-oh. It was previously a popular retirement savings plan for single owners and employees of unincorporated enterprises. However, the Economic Growth and Tax Relief Reconciliation Act of 2001 brought about significant modifications to this tax-favored retirement plan. Therefore, it is very interesting to deeply understand it.
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What Exactly Is the Keogh Plan?
A Keogh plan is a tax-deferred retirement plan for independent contractors and sole proprietorships. It is named after New York State Representative Eugene Keogh, who was instrumental in the passage of the Self-Employed Individuals Tax Retirement Act in 1962. The law became known as the Keogh Act due to his efforts.
The Economic Growth and Tax Relief Reconciliation Act (EGTRRA) of 2001 eliminated the distinction between the Keogh plans and other types of retirement plans. Therefore, these plans are no longer referred to as “Keoghs” under the Internal Revenue Code. It is now referred to as HR-10s or qualified retirement plans. A Keogh is comparable to a 401(k), with larger yearly contribution limits. The administration of these schemes is also more complex than those of other types. Significantly, small businesses organized as limited liability organizations (LLCs), sole proprietorships, or partnerships can use Keoghs.
A solo entrepreneur can set up a Keogh or HR-10 retirement plan in which an amount is deposited each year to the business owner’s retirement funds. Assume the owner decides to contribute a fixed amount of $20,000 to the plan each year. In turn, the money is invested in mutual funds that hold a portfolio of equities or bonds. The owner can withdraw cash as needed during retirement.
Working Principles of the Keogh Plan
The Keogh plans are classified into two types: defined contribution plans and defined benefit plans.
Defined Contribution Plans
In a defined contribution plan, you determine the annual contribution amount. There are two ways to determine the amount: profit-sharing or money purchasing. Using a profit-sharing option, you can contribute up to $61,000 in 2022 or 100% of your pay, whichever is less, to your retirement plan. The amount you select to contribute to a profit-sharing plan is subject to annual modification. Importantly, a money-purchase plan enables you to determine from the beginning how much of your profits can be contributed to a Keogh. The maximum donation amount is set and cannot be altered. Money-purchase plan limits are identical to profit-sharing plan limits: $61,000 in 2022 or 100% of remuneration, whichever is less. Notably, If you are self-employed, you can deduct 25% of the contributions you make for your workers or yourself.
Defined Benefit Plans
Genuinely, defined benefit plans operate similarly to traditional pension plans in that you select a retirement goal for yourself and finance it. Your annual benefit cannot exceed 100% of your average salary for the previous three calendar years, or $245,000 in 2022, whichever is less. Contributions to each type of plan are made pre-tax. You also pay taxes on less each pay period and can take an upfront reduction on your income tax return.
The Keogh Plan vs. 401(k)
The table presented below provides a detailed comparison between The Keogh Plan and 401(k) retirement savings plans.
Conclusion
In conclusion, the structure of the Keogh plan is flexible, allowing for the selection of a defined benefit plan or one of many types of defined contribution plans, such as a profit-sharing plan or money purchase plan. Additionally, it permits larger tax-deductible donations. Thus, highly wealthy persons may favor them over other options.
However, the principal disadvantage of the plan is the enormous administrative load, including the necessity to submit an annual Form 5500 with the IRS and the greater costs associated with creating and maintaining a plan. Thus, before deciding whether it is best for you, you should evaluate a SEP-IRA, SIMPLE-IRA, Solo 401(k), regular or Roth IRA, a Simplified Employee Pension, a Simplified Individual Retirement Account, and a Solo 401(k).
FAQs
A Keogh Plan is a type of retirement savings plan for self-employed individuals and small business owners.
Self-employed individuals and small business owners who are not eligible for other retirement plans can set up a Keogh Plan.
While using Keogh plans, common mistakes to avoid include making the maximum amount of contributions, improperly diversifying investments, and having inadequate knowledge of the rules or conditions.
It is possible to roll over funds from other retirement plans to the Keogh plan without tax or penalty, depending on the conditions of each plan.
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Read more: Retirement Planning
Source: The Balance