A Keogh plan (pronounced KEE-oh), or HR10, is an employer-funded, tax-deferred retirement plan designed for unincorporated businesses or self-employed persons. Contributions to it must come from net earnings from self-employment. The term itself is outdated. The Internal Revenue Service (IRS) now calls them “qualified plans.”
- Keogh plans are designed for use by unincorporated businesses and the self-employed.
- Contributions to Keogh plans are made with pretax dollars, and their earnings grow tax-deferred.
- Keogh plans can invest in securities similar to those used by IRAs and 401(k)s.
Two Types of Keogh Plans
There are two types of Keoghs: defined-contribution plans, which are also called HR(10) plans and defined-benefit plans. The latter includes money-purchase plans and profit-sharing plans. Both types of Keogh plans permit investing in securities, such as bonds, stocks, or annuities, similar to an IRA or a 401(k) plan.
Keogh contribution plans are popular among sole proprietors and small businesses and feature relatively high contribution limits at the smaller of 25% of salary or $57,000 for 2020 ($58,000 in 2021). A defined-benefit plan is set up similar to a pension. In 2019 the IRS allows you to contribute up to $230,000 for 2020 and 2021.
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 History of the Keogh
The Keogh plan, named after U.S. Representative Eugene James Keogh of New York, was established by Congress in 1962, expanded into the Economic Recovery Tax Act of 1981, and reworked again in the Economic Growth and Tax Relief Reconciliation Act of 2001. Contribution maximums vary among Keogh plans.
Before 2001 Keoghs were the go-to retirement plans for the self-employed, but since the law changed and “no longer distinguishes between corporate and other plan sponsors, the term is seldom used,” according to the IRS.
Thanks to legislation enacted by Congress in 2001, Keogh plans are now called “qualified plans” by the IRS.
IRA vs. Keogh
An individual retirement account (IRA) can be established by any individual saving for retirement, as long as they have earned income that qualifies under IRS rules. For both 2020 and 2021, the maximum contribution is $6,000. For persons age 50 or older, an additional $1,000 in catch-up contributions can be made per year until the year when they are 70½ by the end of the tax year. Employers are not permitted to make contributions on behalf of employees.
Both Keoghs and IRAs require distributions at age 70½, and you can access funds as early as 59½ years of age. You can also convert a Keogh into an IRA (traditional or Roth), but you must roll over the funds you remove from a Keogh within a 60-day window to avoid being hit with taxes and potential penalties for early withdrawal. It's best to do this with a direct transfer, trustee-to-trustee. If you're moving Keogh money to a Roth, there may also be taxes due—check with a tax advisor before making any changes, and also to be sure that all relevant tax forms are properly filed for the Keogh.
The primary differences between the two plans are contribution limits and individual versus employer contributions. Posttax 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.
There's another choice as well. When trying to decide between a Simplified Employee Pension (SEP) plan and a Keogh, bear in mind that a Keogh costs more to maintain and comes with more paperwork. However, a Keogh’s contribution limits are much higher, providing the potential to supply more of a cushion in retirement, depending on annual contributions.
The Bottom Line
Retirement plans are an essential piece of any portfolio, and this just as true for the self-employed. After all, securing your future financial freedom is one way to relieve stress in your later years. To view some of the best places to start one of these accounts, you can check out Investopedia’s lists of the best brokers for IRAs and the best brokers for Roth IRAs.