What is the difference between a Keogh and an IRA?

By Steven Merkel AAA
A:

The Keogh plan, or HR10, is an employer-funded, tax-deferred retirement plan designed for unincorporated businesses or self-employed persons. The Keogh plan, named after U.S. Representative Eugene James Keogh, was established by Congress in 1962 and expanded into the Economic Recovery Tax Act of 1981. Keoghs can be either defined-contribution or defined-benefit plans. Contribution maximums vary among Keogh Plans, which include profit-sharing, money purchase and combination plan options.

Keogh plans are popular among sole proprietors and small businesses with high incomes because they feature relatively high contribution limits at the smaller of 25% of salary, or $46,000 (the maximum contribution for 2008). Contributions to Keoghs are made pretax, which reduces the taxable income of the contributor. Self-employed individuals generally can deduct the entire yearly Keogh contribution amount, including contributions made on behalf of employees. The interest, dividends and capital gains earned in Keoghs grow tax-deferred until the beginning of withdrawals.

The Individual Retirement Account (IRA), or Traditional IRA, can be established by any individual saving for retirement. For 2008, the maximum contribution is $5,000. For persons age 50 or older, an additional $1,000 in catch-up contributions can be made per year. Employers are not permitted to make contributions on behalf of employees, because funds contributed by individuals may be tax-deductible. Both Keoghs and IRAs require distributions at age 70.5.

The primary differences between the two plans are contribution limits and individual versus employer contributions. Post-tax contributions can be made to IRA accounts, but Keogh contributions offer higher tax deductions. In addition, Keoghs offer plan choices geared toward self-employed individuals or small business owners, whereas IRAs are restricted to individuals.

(For more on this topic, read the Individual Retirement Accounts special feature.)

This question was answered by Steven Merkel.

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