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What is a Keogh plan?
The tax-deferred pension plan for retirement purposes that is available to self-employed individuals and autonomous businesses is called the Keogh plan.
A Keogh plan can be created as a defined benefit or a defined contribution plan but maximum times most plans are set as a defined contribution plan.
Up to a certain percentage of annual income the contributions are tax-deductible, the Internal Revenue Service (IRS) can change the applicable absolute limits in U.S. dollar terms, from year to year.
Let us understand the Keogh plan
Keogh plans are basically retirement plans for self-employed people and unincorporated businesses, like sole proprietorships and partnerships.
An independent contractor or self-employed person cannot set up and use a Keogh plan for retirement.
Keogh plans are referred to as qualified plans by the IRS, and they are of two types: defined-contribution plans, including profit-sharing plans and money purchase plans, and defined-benefit plans, that is sometimes known as HR(10) plans.
Like 401(k)s and IRAs Keogh plans too can invest in the same set of securities, including stocks, bonds, certificates of deposits, and annuities.
Types of Keogh plans
Qualified defined-contribution plans:
As the name suggests, in a qualified defined contribution plan, the contributions are made on a regular basis up to a limit.
One of the two types of Keogh plans is profit-sharing plans which according to the IRS allows a business to contribute up to 100% of compensation, or $58,000 as of 2021. For this type of plan, a business does not have to generate profits to set aside money.
Compared to profit-sharing plans the money purchase plans are less flexible as they require a business to put up a fixed percentage of its income annually that is specified in plan documents.
A business may face penalties if it changes its fixed percentage. For 2021 the contribution limit for money purchase plans is placed at 25% of annual compensation or $58,000 whichsoever is lower.
Qualified defined-benefit plans:
According to the qualified defined benefit plan the annual benefits are to be received at retirement, and these benefits depend on salary and years of employment.
Based upon returns stated benefits and few factors, like age and expected paybacks on plan assets the contributions of the defined-benefit Keogh plans vary.
For 2021 the topmost annual benefit was set at $230,000 or 100% of the employee’s compensation, depending on whichsoever is lower.
Pros and cons of Keogh plans
Pros:
In 1962 Congress established Keogh plans through legislation and was lead by Rep. Eugene Keogh.
Like all other qualified retirement accounts, Keogh funds can be retrieved as early as age 59½, and withdrawals must start by the age of 72, or 70½ if you were 70½ before Jan. 1, 2020.
Cons:
Compared to Simplified Employee Pension (SEP) or 401(k) plans Keogh plans have more administrative burdens and higher upkeep costs, but the contribution limits are higher, because of which Keogh plans are more accepted option for many well-off business owners.
As the current day tax retirement laws have not differentiated between incorporated and self-employed plan sponsors, the term Keogh plan is seldom used.
Conclusion
The tax-deferred pension plans are either defined-benefit or defined-contribution, Keogh plans are used for retirement purposes by either self-employed individuals or unincorporated businesses, Keogh plan cannot be used by independent contractors.
Profit-sharing plans are one of the two types of Keogh plans, which as of 2021grants a business to put up to 100% of compensation, or $58,000.
There are more administrative burdens and higher upkeep costs with Keogh plans compared to Simplified Employee Pension (SEP) or 401(k) plans, but Keogh plans are a popular option for many high-income business owners because the contribution limits are higher.
The term “Keogh plan” is rarely ever used these days because current tax retirement laws do not set apart incorporated and self-employed plan sponsors.
