What Is a Keogh Plan?
A Keogh plan is a type of tax-deferred retirement plan designed for self-employed individuals and unincorporated businesses. It allows these professionals and business owners to save for retirement in a structured, tax-advantaged manner, offering benefits similar to corporate pension plans or 401(k)s for employees. The Keogh plan falls under the broader category of qualified retirement plans, which are subject to specific Internal Revenue Service (IRS) regulations. Contributions to a Keogh plan are typically made with pre-tax dollars, which can reduce an individual's current taxable income. Funds within the plan grow tax-deferred, meaning earnings are not taxed until withdrawn in retirement.
History and Origin
The Keogh plan, sometimes referred to as an H.R. 10 plan, takes its name from U.S. Representative Eugene James Keogh of New York. Representative Keogh was instrumental in the passage of the Self-Employed Individuals Tax Retirement Act of 1962, which established this type of retirement savings vehicle.13 This legislation was a significant step in addressing the need for self-employed individuals to accumulate retirement savings with similar tax advantages enjoyed by employees of larger corporations. While the underlying principles remain, subsequent legislative changes, such as the Economic Growth and Tax Relief Reconciliation Act of 2001, have led the IRS to generally refer to these plans more broadly as "qualified plans" rather than specifically "Keogh plans."
Key Takeaways
- A Keogh plan is a tax-deferred retirement plan for self-employed individuals and unincorporated businesses.
- It allows for significant tax-deductible contributions, potentially higher than those for individual retirement accounts (IRAs) or some 401(k)s.
- Keogh plans can be structured as either defined contribution plans (e.g., profit-sharing or money purchase plans) or defined benefit plans.
- They typically involve more administrative complexity and higher costs compared to simpler retirement options like SEP IRAs or Solo 401(k)s.
- Contributions and earnings grow tax-deferred, but withdrawals in retirement are taxed as ordinary income, and early withdrawals may incur penalties.
Interpreting the Keogh Plan
Understanding a Keogh plan involves recognizing its structure, which primarily comes in two forms: defined contribution and defined benefit. In a defined contribution Keogh, the annual contribution is determined, and the retirement benefit depends on the investment performance over time. This includes both profit-sharing plans, where contributions can vary based on business profitability, and money purchase plans, which require a fixed percentage contribution annually.12 For a defined benefit Keogh, the future annual retirement benefit is predetermined, and an actuary calculates the annual contribution necessary to reach that target.11
These plans are particularly appealing to high-income self-employed individuals or small business owners because they often allow for higher contribution limits than other popular retirement vehicles. However, the administrative obligations, including annual IRS filings, are more substantial.
Hypothetical Example
Consider Dr. Eleanor Vance, a self-employed dentist operating her practice as a sole proprietorship. In 2024, her net earnings from self-employment are $200,000. She decides to establish a defined contribution Keogh plan structured as a profit-sharing plan.
Based on IRS guidelines for 2024, she can contribute up to 25% of her adjusted net self-employment earnings. Let's assume after specific deductions for self-employment tax, her compensation for plan purposes is $185,000. Dr. Vance decides to contribute 20% of this amount to her Keogh plan.
Her annual contribution would be:
(0.20 \times $185,000 = $37,000)
This $37,000 contribution is tax-deductible for her business. The funds are then invested within the Keogh plan, and any earnings, such as dividends or capital gains, grow without immediate taxation. When Dr. Vance eventually takes distributions in retirement, these amounts will be subject to ordinary income tax.
Practical Applications
Keogh plans serve as a valuable tool for retirement planning for individuals who are self-employed or operate unincorporated small businesses, such as sole proprietors, partnerships, and limited liability companies (LLCs). They are often considered by high-income professionals like doctors, lawyers, and financial advisors who wish to maximize their tax-advantaged retirement savings beyond the limits of standard IRAs or 401(k)s.10
Contributions to a Keogh plan are made with pre-tax dollars, reducing the contributor's taxable income for the year. The accumulated funds within the plan benefit from tax-deferred growth. When it comes to distributions, the rules largely mirror those of other qualified retirement plans, including required minimum distributions (RMDs) starting at age 73 (or 72 for those born before July 1, 1949).9 Detailed guidance on contribution limits, eligibility, and reporting requirements can be found in IRS Publication 560.7, 8
Limitations and Criticisms
Despite their advantages, Keogh plans come with certain limitations and criticisms that have led to a decline in their popularity compared to other retirement vehicles like SEP IRAs and Solo 401(k)ss). One significant drawback is their administrative complexity. Setting up and maintaining a Keogh plan often requires extensive paperwork, including annual IRS Form 5500 filings, which can be time-consuming and may necessitate the assistance of tax and financial advisors.6 This complexity can translate into higher setup and ongoing maintenance costs.5
Furthermore, while Keogh plans are governed by the Employee Retirement Income Security Act of 1974 (ERISA), plans covering only self-employed individuals without common-law employees may not be subject to certain fiduciary standards under the Department of Labor (DOL).3, 4 This distinction underscores the nuanced regulatory environment for these plans. For individuals with lower incomes, the administrative burden and associated costs might outweigh the benefits, as similar contribution capacities could be achieved with less complex alternatives.
Keogh Plan vs. Solo 401(k)
Keogh plans and Solo 401(k)s are both popular tax-advantaged retirement options for self-employed individuals and small business owners with no full-time employees other than the owner (and spouse). While both allow for significant contribution limits, their structures and administrative requirements differ.
| Feature | Keogh Plan | Solo 401(k) |
|---|---|---|
| Plan Types | Can be defined contribution (profit-sharing, money purchase) or defined benefit. | Generally a defined contribution plan, though some versions can include a defined benefit component. |
| Contribution | Employer contributions only (as the self-employed individual is treated as both employer and employee). | Allows for both "employer" contributions (profit-sharing) and "employee" contributions (elective deferrals). |
| Administrative | More complex, often requires a formal plan document and annual Form 5500 filing if assets exceed a certain threshold. | Simpler administration, generally no Form 5500 filing until assets exceed $250,000. |
| Loan Provision | Generally stricter rules; direct loans to owner-employees are prohibited under certain circumstances. | May allow for participant loans, offering access to funds without being a taxable distribution. |
| Catch-Up | Depends on plan type, but typically aligns with qualified plan rules. | Allows for additional catch-up contributions for individuals aged 50 and over. |
| Popularity | Less common today, largely replaced by Solo 401(k)s and SEP IRAs due to complexity. | More popular due to flexibility and simpler administration. |
The primary difference lies in the flexibility of contributions and the administrative burden. A Solo 401(k)) often provides a more streamlined approach with similar high contribution potential, especially with the ability to make both employer and employee contributions.
FAQs
Q: Who is eligible to set up a Keogh plan?
A: Keogh plans are for self-employed individuals and unincorporated businesses, including sole proprietorships, partnerships, and limited liability companies (LLCs). If you are a W-2 employee, you must also have income from independent business activities to qualify for a Keogh plan.2
Q: What are the two main types of Keogh plans?
A: The two main types are defined contribution plans and defined benefit plans. Defined contribution plans include profit-sharing plans and money purchase plans, where the contribution amount is set. Defined benefit plans determine a fixed annual benefit to be received in retirement, with contributions calculated to meet that goal.
Q: Are contributions to a Keogh plan tax-deductible?
A: Yes, contributions to a Keogh plan are generally tax-deductible for the year they are made, reducing your current taxable income. The money contributed and its earnings grow on a tax-deferred basis until withdrawal during retirement.
Q: Can I have a Keogh plan and an IRA or 401(k)?
A: Yes, you can contribute to a Keogh plan even if you also contribute to a traditional IRA or Roth IRA, or if you have a 401(k) through other employment. However, overall contribution limits across all plans must be considered.
Q: What happens if I withdraw money from a Keogh plan before retirement age?
A: Similar to other qualified retirement plans, withdrawals from a Keogh plan before age 59½ may be subject to a 10% early distribution penalty, in addition to being taxed as ordinary income, unless a specific exception applies.1