Keogh Plan

A Keogh Plan, also called an HR10 Plan, is a tax-deferred retirement plan that is designed for self-employed individuals and unincorporated businesses. These plans are particularly beneficial for individuals with self-employment income because they offer flexibility and the potential for significant retirement savings and tax advantages. The term takes its name from the late U.S. Representative Eugene Keogh of New York, who was instrumental in the introduction of the legislation that established these plans in the 1960s.

Types of Keogh Plans

Keogh Plans are divided into two main types:

  1. Defined Benefit Plans: In these plans, the retirement benefits are determined by a formula, usually involving years of service and salary history. Contributions to a defined benefit Keogh Plan are made by the employer and are actuarially calculated to ensure sufficient funding for the promised benefits.

  2. Defined Contribution Plans: These include profit-sharing plans and money purchase plans. In a defined contribution Keogh Plan, the contributions are specified, but the retirement benefits depend on investment performance. The employer and employees can both contribute, and the amount of retirement funds available depends on the contributions and earnings on those contributions over time.

Eligibility and Participation

Eligibility Rules

Keogh Plans are designed for:

Any self-employed person or small business owner who has income from personal services can set up a Keogh Plan. Employees of these businesses can also be included in the plan, provided they meet certain eligibility requirements.

Participation Requirements

Participation requirements for employees typically are:

Contributions

Contribution Limits

The contribution limits for Keogh Plans differ based on the type of plan:

  1. For Defined Benefit Plans: The annual contribution is determined by a formula that calculates the future benefit the plan must pay and considers factors such as age, compensation, and years until retirement. The maximum annual benefit is capped at $230,000 or 100% of the participant’s average compensation for the highest three consecutive years, whichever is lower (as of 2023).

  2. For Defined Contribution Plans: The maximum annual contribution is the lesser of 25% of compensation or $66,000 for 2023. Participants over the age of 50 may also make additional “catch-up” contributions of $7,500.

Deductibility

Contributions made to Keogh Plans are tax-deductible within IRS limits. This allows businesses and self-employed individuals to reduce their taxable income while funding their retirement.

Investments

Keogh Plans allow participants to choose from a broad range of investment options, similar to other qualified retirement plans. Common investment options include:

The investment earnings grow tax-deferred until they are withdrawn during retirement.

Distributions

Withdrawal Rules

Withdrawals from Keogh Plans are subject to the same rules as other qualified retirement plans. Distributions can generally begin without penalty at age 59½, and required minimum distributions (RMDs) must start by April 1 of the year following the year the participant turns 72 (or 73 for those born between 1951 and 1959).

Penalties

Withdrawals made before age 59½ are generally subject to a 10% early withdrawal penalty, unless an exception applies (such as disability or certain medical expenses). Taxes are also due on the withdrawn amount.

Pros and Cons of Keogh Plans

Pros

  1. High Contribution Limits: Keogh Plans offer some of the highest contribution limits among retirement plans, which can lead to significant retirement savings.
  2. Tax Benefits: Contributions are tax-deductible, and investment earnings grow tax-deferred.
  3. Flexibility: Businesses have flexibility in choosing between defined benefit and defined contribution options.
  4. Broad Investment Options: Participants can choose from a variety of investment options.

Cons

  1. Complexity: Setting up and maintaining a Keogh Plan can be complicated and may require professional assistance.
  2. Costs: Administrative costs for defined benefit plans can be high due to the need for actuarial services.
  3. Regulatory Requirements: Keogh Plans must adhere to strict IRS and ERISA regulations.

Choosing a Keogh Plan Provider

Several financial institutions and brokerage firms offer Keogh Plans. It’s essential to choose a reputable provider that offers comprehensive services, including plan setup, administration, and investment options. Some notable providers include:

Conclusion

Keogh Plans can be an excellent retirement planning tool for self-employed individuals and small business owners. They provide high contribution limits and significant tax benefits. However, due to their complexity and regulatory requirements, it is often advisable to seek professional financial and legal advice to set up and maintain these plans.