What is the difference between a Keogh and an IRA?
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.
Although we don't see them very much an more, a Keogh plan is a tax-deferred pension plan available to self-employed individuals or unincorporated businesses for retirement purposes. A Keogh plan can be set up as either a defined-benefit (that will specify or target how much you would be paid as a retirement income strieam) or defined-contribution plan (one where the IRS has limits on how much you can put in annually), although most plans are defined as contributions. The big difference here is that it is funded by your employer. The money in the Keogh will grow tax deferred and when you take the money out in retirement, you will pay taxes on that income at your then current tax-bracket.
An IRA is an individual retirement arrangement (acccount), where you can put in a certain amount each year per IRS Rules for you (or your spouse or even your kids if they have earned income). In 2017, those maximum amountsare $5,500 if < age 50 or $6,500 if > age 50. You must have earned income...l.and you can put in the lesser of your earned income and the amounts and the maximum amounts.
An IRA can also be done as a traditional IRA or a Roth IRA. For the Traditional, depending on your income or other factors you may be able to take a tax deduction on your personal tax return (1040). The money will grow tax deferred and you will pay tax on the distributions in retirement if you deducted the full amount when it was deposited (if not, you have tax-basis you will track and only pay tax on the earnings when withdrawn).
For a Roth IRA, you don't get a deduction when you put the money in, it grows tax free and pays out tax free. However there are some limitation on who can contribute to a Roth and how long you have to wait to take your money out.
The rules can be confusing, but here are a few articles from my website to check out:
An Individual Retirement Account (IRA) is a type of personal retirement savings account that allows you to save for your retirement with tax advantages. Whereas a Keogh is a more complex type of retirement account for self-employed business owners, partners in a company and their employees.
- An IRA is set up by an individual and has nothing to do with your employer.
- A Keogh is set up by a business for its employees including the business owners.
- With a Keogh account, the contributions are made by the business into employees’ accounts.
- IRA contributions are made by individuals into their own accounts.
- Limits are placed on both types of accounts, but more funds can be placed in a Keogh than in an IRA.
- In both IRA and Keogh accounts, the individual decides where the funds are invested, such as mutual funds, stocks and bonds or a combination.
- Funds contributed to an IRA directly reduce the amount of money you owe taxes on. When you withdraw funds from the IRA, after you are at least 59 1/2 years old, you pay income taxes at whatever your tax rate is at that time.
- Keogh contributions do not impact individuals' personal tax situation directly. Instead, contributions are deductible for the business. Upon retirement, withdrawals are taxed as income to the individuals.
Keogh plans get their name from the man who created them, Eugene Keogh, who established the Self-Employed Individuals Tax Retirement Act of 1962 or the Keough Act. The plans have changed over the years and the Internal Revenue Code no longer refers to them as Keoghs. They are now known as HR 10 or qualified plans.
The Keogh structures still exist, but they have lost popularity compared to plans like SEP-IRAs or individual or solo 401(k)s. A Keogh may be right for a highly paid professional, such as a self-employed dentist or a lawyer.
There are many differences between these plans. However, the two major differences are:
1.) A Keogh is and employer funded retirement account and an IRA is an individually funded retirement account.
2.) A Keogh and an IRA have different contribution limits.
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This is a complicated question, but a Keogh is a retirement plan that for unicorporated businesses like sole proprietorships and partnerships, or self-employed individuals. They can be set up either as a Defined Benefit Plan (pension plan) or a Defined Contribution Plan (either a Profit Sharing or Money Purchase - 2 of the 7 types of 401k plans). But the real takeaway is that you can put in much more money into a Keogh Plan that you could an IRA. IRA limits are $5,500 under 50 & $6,500 50 or over each year. Whereas, a Keogh Profit Sharing Plan, you could put in up to 25% of compensation up to $53,000. So it leave you flexible. A Money Purchase Keogh Plan is less flexible as you must chose a fixed percentage up to 25% or $53,000, but if you change the fixed percentage, you may face penalties.
A Keogh Defined Benefit Plan defines the benefit at the end versus the contribution going into the plan. The maximum (indexed each year) is $210,000 for 2016 so contributions to be able to fund the benefit on the backend can be much larger than $53,000. The contribution will be based upon age, expected return, and other variables. These plans work well for high income earners with no or few employees because they must be covered as well.
Again these can be complicated so you need to seek competent advice by someone who is well versed in the benefits and drawbacks of there plans. And there are other types of plans that benefit high income individuals.
Hope this helps and best of luck, Dan Stewart CFA®