Keogh Plan

What is a Keogh Plan?

A Keogh is a retirement plan for a self employed professional or an owner of a small business and its employees. You must be a sole proprietorship, a partnership or a limited liability company (LLC).

In a Keogh the employer makes 100% of the contributions. Dividends and investment earnings in a Keogh grow tax-deferred until withdrawn. You cannot withdraw money from your Keogh without a potential tax penalty before you are age 59 1/2 or older .

There are 2 types of Keogh retirement plans, a defined benefit Keogh plan and a defined contribution Keogh plan.

Defined Benefit Keogh Plan

A defined benefit Keogh plan is more complex and requires the services of a pension specialist. These are similar to traditional pension plans that were common years ago. In this plan, 100% of the contributions are made by the employer to themselves and to eligible employees. Within certain limits, the employer can choose the specific amount received from the retirement fund at retirement. To reach this amount at retirement, a specific contribution is made by the employer into the Keogh account based on a complex actuarial formula. Some of the factors involved in the actuarial formula are age and life expectancy, estimated retirement benefit amount and years until retirement. These and other factors determine the amount that can be contributed each year into a defined benefit plan.

A defined benefit plan rewards older participants more, whether they are employees or owners, because larger contributions are required by the employer to fund a specified future benefit since they have fewer years until retirement.

How much paperwork is there for a Defined Benefit Keogh Plan?

A defined benefit Keogh is more complex and expensive administratively and requires the services of an actuary or pension specialist. This may be an ideal plan for older owners that want to maximize their retirement contributions beyond the limits allowed by a defined contribution plan.

Defined Contribution Keogh Plan

A defined contribution Keogh plan is much less complex and inexpensive administratively. 100% of the contributions are made by the employer to themselves and to eligible employees. The employer and eligible employees must receive the same contribution percentage based on their income into their individual accounts.

In a defined contribution Keogh plan, the value of your retirement plan at retirement depends on the amount of your annual contributions and the growth rate of your investments. Common investments inside this type of Keogh are stocks, bonds and mutual funds. For 2012 the maximum contribution is $50,000. Prior to the 2001 EGTRRA law, defined contribution Keogh plans were a popular choice for self employed business owners. This law change made an Individual 401k or a SEP IRA more advantageous than a defined contribution Keogh plan for most self employed individuals and small business owners.

Why is a SEP IRA potentially more advantageous than a defined contribution Keogh plan?

A SEP IRA and a Keogh plan both have a maximum annual contribution limit of $50,000, but a Keogh plan has more paperwork since it is required that IRS form 5500 is completed annually. With a SEP IRA form IRS form 5500 does not need to be completed.

Why is an Individual 401k potentially more advantageous than a defined contribution Keogh plan?

An Individual 401k may allow a greater contribution than a Keogh plan due to the way the annual contribution is made. As a result, a self employed individual may be able to contribute more into an Individual 401k versus a Keogh plan at the same income level, therefore maximizing retirement contributions and valuable tax deductions. To determine how much you can contribute based on your income use
the Individual 401k calculator.

How much paperwork is there for a Defined Contribution Keogh Plan?

There is more administration and paperwork than a SEP-IRA, Traditional or Roth IRA including possible yearly IRS Form 5500 filings.

Who can have a Keogh Plan?

A Keogh plan is designed for the self-employed professional or owner of an unincorporated small business and its employees. In other words you must be a sole proprietorship, a partnership, or a limited liability company (LLC).

How do you determine net or earned income?

The amount of the contribution you can make to your Keogh plan is determined by the amount of your " net income" or "earned income" for the year. Earned income is defined as your gross income from a trade or business, minus any allowable deductions. Income received by a passive partner is considered to be investment income rather than earned income and would not be eligible for either Keogh plan.

Can I contribute if I have more than one business?

Yes, if an owner-employee has more than one business but only one business has a Keogh plan. Contributions and deductions are based only on the earned income from the business that has the plan.

When can I set up my Keogh for it to be tax deductible?

You must set up the Keogh by the end of the calendar year in order for your contributions to be deductible for that tax year.