Keogh Plan

A Keogh plan is a particular kind of retirement account that self-employed workers can set up. High contribution limits, pre-tax contributions, and the flexibility to choose between defined contribution and defined benefit plans are all features of Keogh plans that appeal to savers. Keogh plans might provide business owners with a clever approach to invest for their retirement.

What is a Keogh Plan ?

A Keogh plan (also known as HR-10 or qualified retirement plan) is a tax-deferred pension plan available to unincorporated businesses or self-employed individuals for retirement purposes. Although most plans are set up as the latter, a Keogh plan can be set up as either a defined-benefit plan or a defined-contribution plan. Contributions are typically tax-deductible up to a specific percentage of annual income, with applicable absolute limits in U.S. dollar terms, which the IRS (Internal Revenue Service) can change from year to year.

A Keogh plan is a retirement plan that permits tax-deductible contributions from self-employed people up to $61,000 annually. Both self-employed people and those who work for them can create a Keogh Plan. Keogh plans may be established by small enterprises, partnerships, limited liability corporations (LLCs), and sole proprietorships.

Key Facts of Keogh Plan

  • A Keogh plan is an unincorporated firm or self-employed person's form of retirement plan. 
  • Keogh plans are tax-deferred pension plans.
  • The IRS currently refers to this kind of plan as a "HR-10" or "qualified retirement plan".
  • Small businesses that are organized as partnerships, sole proprietorships, or limited liability organizations (LLCs) can use Keoghs. A Keogh plan cannot be used by independent contractors.
  • Similar to 401(k)s, Keogh plans offer larger annual contribution limits (specifically when used by very small businesses).

History of Keogh Plans

Keogh plans were named after Eugene James Keogh, a New York congressman. The Self-Employed Individuals Tax Retirement Act of 1962, a piece of legislation permitting unincorporated firms to sponsor retirement plans for employees, was made possible in large part because to the congressman. The Keogh plans are now known as qualified retirement plans or HR10 plans, according to the IRS, who also emphasized that this phrase is out of date.

The distinction between Keoghs and other plans was eliminated in 2001 by the Economic Growth and Tax Relief Reconciliation Act (EGTRRA). As a result, these plans are no longer referred to as "Keoghs" under the Internal Revenue Code. Keoghs are now referred to as "HR-10s" or "qualified retirement plans," respectively.

How Does a Keogh Plan Work ?

A Keogh plan is a particular kind of retirement plan for freelancers and people who work for unincorporated enterprises. Pre-tax monies may be used to fund Keogh plans, subject to yearly contribution caps.

Keogh plans can be set up as defined benefit plans, which ensure a specific retirement income. However, the majority are defined contribution plans, which don't guarantee an income but instead let employees put aside a predetermined amount of their pay.

For self-employed people operating unincorporated firms, Keogh plans were established up. To be eligible, W-2 employees must earn money from their own independent businesses. Keoghs are subject to the same tax regulations as IRAs and other qualified retirement accounts.

Contributions made using a Keogh are tax deductible. Your account grows tax-free after you make a contribution, but qualifying distributions are subject to income tax. Whether your plan is a defined contribution (DC) plan or a defined benefit plan, Keogh's tax treatment is the same in both cases. Any distributions from the Keogh plan made prior to the age of 5912 are also subject to a 10% early distribution penalty in addition to income taxes on withdrawals.

Example of Keogh Plan

A solo proprietor could set up a Keogh or HR-10 retirement plan whereby an annual sum is put into the firm owner's retirement savings. Let's say the owner chooses to make a fixed $20,000 annual contribution to the plan. The money is then invested in mutual funds that hold a portfolio of stocks or bonds. The owner may take out money when they retire as needed.

Types of Keogh Plans

There are two types of Keogh plans available are as follows :

1) Defined Contribution Plans :

Keogh plans may be configured as qualified defined-contribution plans, in which regular contributions are made up to a predetermined maximum. In a defined contribution plan, you specify the annual amount you'll make to the fund. The amount can be specified in either a profit-sharing or money-purchasing manner.

i) Profit-sharing plans :

You may make a profit-sharing contribution to your plan in 2022 up to $61,000 or up to 100% of your compensation, whichever is less. Your annual contribution amount to a profit-sharing plan is up to you.

ii) Money purchase plans :

Similar to a profit-sharing plan, they are a sort of defined contribution plan where companies must make annual contributions whether or not they generate a profit. How much of your profits you can invest in a Keogh depends on the money-purchase plan you choose. The contribution cap is fixed and cannot be changed. The money-purchase plan's limits are $61,000 in 2022 or 100% of compensation, whichever is less, much like for profit-sharing.

2) Defined Benefit Plans :

The annual benefits to be received upon retirement are specified in qualified defined-benefit plans, and these benefits are often based on pay and years of employment. According to stated benefits as well as other considerations including age and anticipated returns on plan assets, contributions to defined-benefit Keogh plans are calculated.

Your annual benefit must be greater than $245,000 for 2022 or 100% of your average compensation over your three highest consecutive calendar years. Pre-tax contributions are made to each type of plan. You can choose to take an upfront deduction on your income tax return, and you also pay taxes each pay period on less of a regular basis.

Who is Eligible for Keogh Plan ?

Keogh Plan is designed for small businesses. Sole proprietors, partnership firms, associations of people, groups of people, self-employed people, and other non-corporate entities are all eligible for the Keogh Plan.

An individual cannot establish and use a Keogh plan for retirement if they are an independent contractor. Also, one member of the partnership cannot create such a plan on their own.

These plans are only available to workers who have been working for the company for at least two years and have put in at least 1000 hours annually.

Keogh Plan Rules

Keogh plans must adhere to Qualified Plan rules set forth by the IRS. The following are some of the IRS regulations :

1) To establish, must be self-employed :
To qualify, you must generate income from your own business. Even if you have another plan at work and self-employment income, you are still eligible.

2) Can be a defined benefit or defined contribution plan :
Whichever you use, be in mind that prices will vary. Defined benefit plans involve actuarial fees in addition to higher contribution limitations as a percentage of income.

3) Must offer to qualified employees :
Any employee who is 21 years of age or older and works at least 1,000 hours annually for your company must have access to the plan.

4) Contribution :
Tax deductions for contributions are allowed up to annual restrictions. Similar to a simplified employee pension IRA, Keogh plan contributions must be made before to your tax filing deadline for the contribution year.

5) Before year's end, it must be set up :
Keogh plans cannot be established between the end of the year and the deadline for reporting your taxes, unlike IRAs. The plan must be implemented during the year for which it’s effective.

6) No withdrawals before age 59½ : 
Like an IRA, Keogh plans do not allow withdrawals before age 59½.

7) Required minimum distributions at the age 72 : 
When you turn 72, you must begin taking mandatory distributions from your Keogh account if there is still money in it.

8) Penalty :
After the age 59 ½, withdrawals are free of penalties. Absent a hardship exemption, you are subject to a 10% penalty for early withdrawals.

9) Pay taxes on distributions :
Keogh plan withdrawals are subject to income tax, much as IRA withdrawals. Although a Roth conversion may result in tax debt, a Keogh plan can be rolled over into either a standard or Roth IRA.

10) Must file IRS Form 5500 :
Keogh plans are different from IRAs in that business owners must submit Form 5500 to the IRS every year with information about their plan.

Keogh Plan Contribution Limits

A Keogh plan may be set up as a pension-like defined benefit plan or as a defined contribution plan. The amount of contributions varies depending on how your plan is set up. Keogh plan contribution limits are set by the IRS and can change annually.
  • Self-employed people are permitted to contribute up to $61,000, or 25% of their pretax income.
  • If the Keogh is a defined benefit plan or if it is your only retirement plan because you are self-employed, you may make tax-deferred contributions totaling up to 100% of your pretax income, or $61,000.

You can deduct the amount of your contribution from your taxes for the year you made it since Keogh plan contributions are made before taxes. Once you retire, you must pay taxes on the whole plan's balance.

Keogh Plan Contribution Limits 2022

Defined contribution plan

      Profit-sharing plan: up to 25% of compensation or $61,000

      Money purchase plan: up to 25% of compensation

Defined benefit plan

Up to $245,000 or 100% of your compensation, whichever is less

Keogh Plan Withdrawal Rules

Starting at the age of 59 ½, Keogh plan withdrawals are free from penalties. Withdrawals made before to this period are additionally subject to regular income tax and a 10% penalty. You must withdraw money from the account before you turn 70 ½ to avoid a 15% penalty tax.

How to Set up Keogh Plan ?

Keogh plans are only available to self-employed individuals and unincorporated firms. You must adopt a written plan that complies with IRS Publication 560 when you start a Keogh plan, however many financial organizations, including banks and brokerage firms, can give you examples of plans that the IRS has approved.

You can invest the money in a Keogh plan in stocks, mutual funds, bonds or other investments. You are also required to file IRS Form 5500 annually.

However, you can make contributions for the previous year before you file your tax return by mid-April if you establish your qualifying retirement plan before the end of the year you desire to earn the deduction. You have until mid-October to file a tax extension.

When to Use Keogh Plan ?

Many self-employed workers who could have previously used a Keogh are now making investments in substitutes. If you can find a supplier, the following scenarios may help you with a Keogh :

An self-employed individual with a high income :
Keogh plans offer high contribution limits and need self-employment income (for those making above $150,000 annually).

Owners of small businesses who want a pension :
While most IRAs can only be set up as defined contribution plans, Keoghs can be set up as pension-like defined benefit plans.

Individuals with self-employment income, who do not have another retirement plan :
You can contribute more than IRAs (up to $61,000) if you are self-employed and do not have any other retirement plans besides a Keogh. You can contribute up to 100% of your income in this situation.

What is the advantages of Keogh Plan ?

  • Individuals and small company owners can contribute tax-deferred amounts of up to $61,000 year using a Keogh.
  • Until withdrawals are made after you turn 59½, your account grows tax-free.
  • Most IRAs have a 25% contribution cap, but Keogh contribution caps might be greater if they're set up as defined benefit plans.
  • Investment in mutual funds, bonds, annuities, and other similar choices that are accessible under the standard 401(k) plan are also available here.
  • The simplicity of flexibility on the contributions here also serves the fundamental benefit of retirement.
  • Additionally, the tax authorities will not charge you taxes on contributions that are legitimately tax-deductible.
  • The professionals gain from this. These are the small business associations.

What is the disadvantages of Keogh Plan ?

  • The main prerequisite for this plan's eligibility is that it only applies to small company organizations. You must therefore be self-employed in order to profit from this plan.
  • These strategies are nevertheless subject to some risk because the investments produce bigger returns.
  • If a person needs to withdraw before the required age, they must pay the penalty.
  • When you absolutely need the money for disposal, the hard-earned money takes a hit due to penalty.
  • Due to a variety of reasons, including the plan's legal compliances, the expense of managing the plan is considerably higher.

What is the differences between Keogh plan and 401(k) plan ?

A 401(k) plan is a more recent alternative to a Keogh plan, and while they have some similarities, the 401(k) has grown in popularity due to its differences.

A 401(k) is a qualifying defined contribution plan that is sponsored by employees. Employees can often open a 401(k) if their workplace provides one. Occasionally, depending on their regulations, the employer will also make a portion of the contributions in addition to those made by the employee.

401(k) plans are more generally available, whereas Keogh plans are exclusively accessible to self-employed individuals and their employees. Solo 401(k) plans, often referred to as one-participant 401(k) or individual 401(k) plans, are available to self-employed people and are virtually identical to conventional 401(k) plans.

Self-employed workers who participate in one-participant 401(k) plans may contribute up to $61,000 in 2022, or an additional 25% of their net earnings, in addition to the regular contribution limitations ($20,500 in 2022). Keogh plans have more administrative requirements, but 401(k) plans are less complicated to set up and administer.