Keogh Plan
A retirement plan that can be set up by self-employed individuals and those who work for them
What is a Keogh Plan?
A Keogh Plan is a retirement plan that can be set up by self-employed individuals and those who work for them. Small businesses, partnerships, limited liability companies (LLCs), and sole proprietorships are eligible to establish Keogh plans. Keogh plans are still used today; however, they’ve declined in popularity, with individual/single 401(k)s and SEP IRAs climbing to the top of the list of retirement plan options.
Keogh plans are similar to 401(k)s, except that they offer higher yearly contribution limits (specifically when used by very small businesses). They only make sense for certain types of self-employed individuals (and their employees). Cases where a Keogh plan makes sense include:
- Lawyers
- Dentists
- Financial professionals
Keogh plans can only be established if the individuals mentioned above created their own businesses.
Summary:
- A Keogh plan is a unique retirement plan designed for self-employed individuals (and their employees).
- The Keogh plan gets its name from New York Representative Eugene Keogh who established the Self-Employed Individuals Tax Retirement Act of 1962.
- The plan is fairly uncommon now and comes with a set of limitations that are not present in other retirement plans.
History of Keogh Plans
Keogh plans are also sometimes referred to as HR10 plans. The U.S. Internal Revenue Service (IRS) calls them qualified plans. They got their actual name from New York Representative James Keogh. He was responsible for creating the Self-Employed Individuals Tax Retirement Act of 1962, which is alternatively known as the Keogh Act.
In 2001, the basic outline of the act – and the name – were changed. It is now known as the Economic Growth and Tax Relief Reconciliation Act (EGTRRA). Because the changes were so extensive, the IRS no longer considers it the Keogh Act but instead refers to it simply at the HR10 Plan.
Types of Keogh Plans
1. Defined Benefit Plan
The defined benefit plan is structured using a fixed contribution, which involves a set sum of money or a fixed percentage of an individual’s income. (This is also sometimes referred to as a money purchase Keogh plan.) It is done per each period of pay.
The defined benefit plan can sometimes be set up as part of a profit-sharing plan, wherein an individual can withdraw a specified amount, but the amount is based on how much the individual invested in their plan during the time that they worked.
2. Defined Contribution Plan
The second type is a defined contribution plan, which is significantly more complex. The basic structure of a defined contribution plan allows for an individual to put a percentage of his or her income aside. However, instead of being a set amount, the amount is based on a formula created by the IRS. (This is the version that is known as an HR10.)
Whether the Keogh plan is a defined benefit or defined contribution plan, it can be invested in financial instruments such as annuities, bonds, stocks, certificates of deposit, or mutual funds.
Plan Limitations
Again, a Keogh plan is less common than nearly all other types of retirement plans. In addition, it comes with a set of limitations.
First, a Keogh plan involves substantially more administrative paperwork than something like a traditional IRA or a SEP IRA. Most other retirement plans can be set up by the individual; a Keogh plan involves a complicated set of calculations.
Second, a Keogh plan cannot be used by self-employed individuals who function as independent contractors. They can only be used by individuals who own an unincorporated business (and the employees who work for that business).
Finally, any contribution made to a Keogh plan must be done pre-tax, which means that the amount is deducted from the tax for the year; however, all taxes must be paid in full on the plan’s balance at the time of retirement.
Related Readings
CFI is the official provider of the Financial Modeling and Valuation Analyst (FMVA)™ certification program, designed to transform anyone into a world-class financial analyst.
In order to help you become a world-class financial analyst and advance your career to your fullest potential, these additional CFI resources will be very helpful:
