What Is a Keogh Plan
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 or defined-contribution plan, although most plans are set as defined contribution. Contributions are generally tax deductible up to a certain percentage of annual income, with applicable absolute limits in U.S. dollar terms, which the Internal Revenue Service (IRS) can change from year to year.
Breaking Down Keogh Plan
Keogh plans are retirement plans for self-employed people and unincorporated businesses, such as sole proprietorships and partnerships. If an individual is an independent contractor, they cannot set up and use a Keogh plan for retirement.
The IRS refers to Keogh plans as qualified plans, and they come in two types: defined-benefit plans, which include profit-sharing plans and money purchase plans, and defined-contribution plans, also known as HR(10) plans. Keogh plans can invest in the same set of securities as 401(k)s and IRAs, including stocks, bonds, certificates of deposit and annuities.
Keogh Plan No. 1: Qualified Defined-Contribution Plans
Keogh plans can be set up as qualified defined-contribution plans, in which the contributions are made on a regular basis up to a limit. Profit-sharing plans are one of the two types of Keogh plans that allow a business to contribute up to 25 percent of compensation or $56,000, as of 2019, according to the IRS. A business does not have to generate profits to set aside money for this type of plan.
Money purchase plans are less flexible compared to profit-sharing plans and require a business to contribute a fixed percentage of its income every year that is specified in plan documents. If a business alters its fixed percentage, it may face penalties. The contribution limit in 2017 for money purchase plans is set at 25 percent of annual compensation or $56,000, whichever is lower.
Keogh Plan No. 2: Qualified Defined-Benefit Plans
Qualified defined-benefit plans state the annual benefits to be received at retirement, and these benefits are typically based on salary and years of employment. Contributions towards defined-benefit Keogh plans are based on stated benefits and other factors, such as age and expected returns on plan assets. In 2018, the maximum annual benefit was set at $225,000 or 100% of the employee's compensation, whichever is lower.
Advantages and Disadvantages of Keogh Plans
Keogh plans were established through legislation by Congress in 1962 and were spearheaded by Rep. Eugene Keogh. As with other qualified retirement accounts, funds can be accessed as early as age 59 1/2, and withdrawals must begin by age 70 1/2.
Keogh plans have more administrative burdens and higher upkeep costs than Simplified Employee Pension (SEP) or 401(k) plans, but the contribution limits are higher, making Keogh plans a popular option for many high-income business owners. Because current tax retirement laws do not set apart incorporated and self-employed plan sponsors, the term "Keogh plan" is rarely ever used.