Understanding the Keogh Retirement Plan: A Comprehensive Guide for the Self-Employed

A Keogh retirement plan is a tax-deferred retirement savings plan specifically designed for self-employed individuals and small business owners. It allows you to contribute a portion of your self-employment income to a retirement account, potentially reducing your current tax burden while building a nest egg for your future. Think of it as a 401(k), but tailor-made for those who answer to themselves.

A Deeper Dive into Keogh Plans

Keogh plans offer a powerful avenue for self-employed individuals to save for retirement. Unlike traditional employer-sponsored plans, Keogh plans require the individual to act as both employer and employee. Understanding the nuances of these plans is crucial to maximizing their benefits.

Types of Keogh Plans

There are two primary types of Keogh plans, each with its own contribution rules and benefits:

• Defined Contribution Plan: With a defined contribution plan, you contribute a fixed amount or percentage of your income each year. The eventual payout depends on the performance of the investments within the plan. There are two types of defined contribution Keogh plans:

  • Money Purchase Plan: This plan requires you to contribute a fixed percentage of your net self-employment income each year, regardless of your business’s profitability. The maximum contribution is 25% of your compensation, up to a certain limit ($69,000 for 2024).
  • Profit-Sharing Plan: Offers more flexibility than a money purchase plan. You can choose how much to contribute each year, or even contribute nothing at all, subject to IRS limits. The maximum contribution is also 25% of your compensation, up to the same dollar limit of $69,000 for 2024.

• Defined Benefit Plan: This type of plan promises a specific retirement benefit based on factors like salary and years of service. It’s more complex to administer and is generally favored by older self-employed individuals who want to maximize their retirement savings in a shorter time frame. The amount you can contribute each year is determined by an actuary and is based on the benefit you wish to receive at retirement. This can allow for substantially higher contributions than defined contribution plans, but also entails more paperwork and expense.

Who Can Open a Keogh Plan?

If you’re self-employed, own a small business (sole proprietorship, partnership, or LLC), and earn income that is subject to self-employment tax, you are generally eligible to open a Keogh plan. If you have employees, you may be required to include them in the plan, following specific IRS guidelines regarding vesting and contribution amounts.

Benefits of a Keogh Plan

Keogh plans offer several advantages:

• Tax Deferral: Contributions are tax-deductible, reducing your current taxable income. The earnings within the plan grow tax-deferred, meaning you don’t pay taxes on them until you withdraw them in retirement.
• Higher Contribution Limits: Compared to traditional and Roth IRAs, Keogh plans allow for significantly higher contribution limits, enabling faster retirement savings accumulation.
• Flexibility: Profit-sharing plans offer contribution flexibility, allowing you to adjust contributions based on your business’s performance and your financial situation.
• Retirement Security: Keogh plans provide a dedicated source of retirement income, helping you secure your financial future.

How to Establish and Manage a Keogh Plan

1. Choose a Plan Type: Determine which type of Keogh plan – defined contribution (money purchase or profit-sharing) or defined benefit – best suits your needs and circumstances.
2. Select a Financial Institution: Open a Keogh account with a bank, brokerage firm, or other financial institution that offers Keogh plan services.
3. Complete the Paperwork: Fill out the necessary forms to establish the plan and designate beneficiaries.
4. Contribute Regularly: Make consistent contributions to maximize the benefits of the plan.
5. Manage Investments: Choose appropriate investments based on your risk tolerance and retirement goals.
6. Comply with IRS Regulations: Ensure you adhere to all IRS rules and regulations regarding contributions, distributions, and reporting.

Frequently Asked Questions (FAQs) About Keogh Plans

Here are some frequently asked questions to help you better understand Keogh retirement plans:

1. What is the difference between a Keogh plan and a SEP IRA? A SEP IRA is simpler to administer than a Keogh plan and has a more straightforward contribution structure. However, Keogh plans, particularly defined benefit plans, may allow for higher contributions in certain situations. The best choice depends on your individual circumstances and retirement goals.

2. Can I have both a Keogh plan and a 401(k) plan if I have multiple sources of income? Yes, if you are self-employed and also employed by another company that offers a 401(k), you can participate in both plans. However, there are limitations on how much you can contribute in total across all plans. You should consult with a tax advisor to determine the optimal strategy.

3. What happens if I withdraw money from my Keogh plan before retirement? Withdrawals before age 59 ½ are generally subject to a 10% early withdrawal penalty, in addition to regular income tax. There are a few exceptions to this rule, such as for certain medical expenses or disability.

4. How do I calculate my maximum deductible Keogh contribution? For defined contribution plans, the maximum deductible contribution is generally 25% of your net self-employment income, up to a certain limit (e.g., $69,000 in 2024). The calculation can be complex, especially for defined benefit plans, so it’s best to consult with a tax professional.

5. Are Keogh plans protected from creditors in case of bankruptcy? Generally, Keogh plans are protected from creditors under federal law. This protection can provide peace of mind knowing that your retirement savings are safe even in challenging financial circumstances.

6. What is the deadline for contributing to a Keogh plan for a given tax year? For self-employed individuals, you generally have until the tax filing deadline (including extensions) to make contributions to your Keogh plan for the previous tax year.

7. Can I roll over funds from a Keogh plan to another retirement account? Yes, you can roll over funds from a Keogh plan to another retirement account, such as a traditional IRA or another qualified retirement plan, without incurring taxes or penalties.

8. Do I need to file any special forms with the IRS for my Keogh plan? Yes, depending on the type and size of your Keogh plan, you may be required to file certain forms with the IRS, such as Form 5500.

9. How do I choose the right investments for my Keogh plan? Choosing the right investments depends on your risk tolerance, time horizon, and retirement goals. Consider diversifying your portfolio across different asset classes, such as stocks, bonds, and real estate. Consulting with a financial advisor can help you develop an appropriate investment strategy.

10. What happens to my Keogh plan if I become employed by another company? If you become employed by another company, you can typically leave your Keogh plan as is and continue to manage it. Alternatively, you can roll over the funds to another retirement account, such as an IRA or the new employer’s 401(k) plan.

11. Are there any fees associated with Keogh plans? Yes, there may be fees associated with Keogh plans, such as administrative fees, investment management fees, and transaction fees. These fees can vary depending on the financial institution and the type of plan.

12. How does the SECURE Act affect Keogh plans? The SECURE Act made several changes to retirement plans, including Keogh plans. These changes may affect the age at which you must begin taking required minimum distributions (RMDs) and the rules regarding beneficiary designations. It’s important to stay informed about these changes and consult with a financial advisor or tax professional to understand their impact on your Keogh plan.

By understanding the intricacies of Keogh plans and their benefits, self-employed individuals can take control of their retirement savings and build a secure financial future. Remember to seek professional financial and tax advice to make informed decisions tailored to your specific circumstances.