SEP Plan vs. Keogh Plan: An Overview

If you are self-employed or own a small business, and you want to put away more than the individual retirement account (IRA) contribution limit each year, you have a couple of good options. Both the Simplified Employee Pension (SEP) plan and the Keogh plan are designed for small business owners and their employees. They are similar in some ways:

  • Employees, as well as the business owner, may participate in these plans.
  • All participants can deduct the amounts that they contribute from their taxable income each year.
  • The money withdrawn after retiring is taxed as ordinary income.
  • The account can be opened at just about any bank, brokerage, life insurance carrier, or mutual fund company.
  • The money can be invested in any of a wide range of assets including stocks, bonds, mutual funds, and exchange-traded funds.

Both plans also have notably higher contribution limits than most retirement plans allow. For 2021, the maximum contribution for SEP accounts and most Keogh plans is the lesser of 25% of net earnings or $58,000.

The SEP Plan

As the name implies, a SEP is fairly simple in structure and functions solely as a defined-contribution plan. That is, the participant automatically earmarks a percentage of gross income to be paid into a tax-deferred retirement account.

A SEP can be established by submitting Form 5305-SEP to the Internal Revenue Service (IRS). A business owner can get through the initial paperwork without the need for professional assistance.

Fewer Requirements

There are no annual filing requirements.

Employers are not required to make a contribution to their employees' plans in any given year. If they make a contribution, it must be made equally to every full-time employee who is at least age 21 and has worked for the company for at least 3 of the past 5 years.

The SEP resembles an IRA in that participants can make contributions for the previous year up to the filing deadline, even if an extension has been granted. Participants cannot borrow from their plan balances.

The Keogh Plan

The Keogh plan is most popular with very high earners, such as physicians who are principals in medical practices and owners of unincorporated small businesses.

It is much more complex than the SEP. It falls under the guidelines of the Employee Retirement Income Security Act (ERISA), the federal law that sets minimum standards for employer-sponsored retirement and health plans. That makes a Keogh a "qualified plan" by definition.

Documentation Requirements

Establishing a Keogh for your business requires a complete plan document to be submitted to the government. In most cases, it’s wise to enlist a certified public accountant or financial advisor to help you prepare and submit the plan. A Keogh plan can have some tricky details that can come back to bite you if they are ignored.

The Keogh can be structured as either a defined-contribution or a defined-benefit plan.

High Contribution Limits

If it is structured as defined-contribution plans, the contribution limits are the same as for a SEP. That is, the maximum for tax year 2021 is the lesser of 25% of net earnings or $58,000.

The limits are higher for a defined-benefit plan. For tax year 2021, it is $230,000.

A defined-benefit plan is similar to a pension in that it establishes a set benefit amount to be paid in equal installments during the retirement of the planned participant.

The defined contribution plan can be structured as a money purchase or a profit-sharing plan. Many business owners opt for the latter because it allows them to make different contributions each year, corresponding to their profits.

Money purchase pension plans do not have this flexibility. The business owner must elect to contribute a set percentage every year for the life of the plan. Penalties are assessed if an annual contribution falls below that amount.

These plans come with annual reporting requirements on Form 5500. Loans against the balance can be taken within certain restrictions.

Special Considerations

If you run a small business and you would like to establish a plan for your employees as well as yourself, a SEP makes sense.

Just remember that you will have to make the same contribution for every employee that you put in your own account each year. This is why SEP plans are mostly used by companies with a small number of eligible employees.

If you make several hundred thousand dollars a year, you have the income and the future expectations to consider a defined-benefit Keogh plan. It's basically a fund-your-own-pension program with tax savings rolled in.

If you got this far and realize that neither of these plans exactly fits your needs, you might consider a solo, traditional or Roth 401(k) plan. If you prefer a defined benefit, look into a 412(i) plan.