A Keogh Plan—pronounced kee-yo—is a type of retirement plan set up by self-employed individuals and their employees. First established by the Self-Employed Individuals Tax Retirement Act of 1962, Keogh Plans can be established by sole proprietorships, partnerships and limited liability companies as a tax-advantaged way to save for retirement. They are not for use by incorporated businesses or independent contractors and are less widely used than other retirement plans for the self-employed, such as SEP or SIMPLE individual retirement accounts.
Keogh Plans have undergone numerous changes since their inception, with the most significant taking place in 2001. The Economic Growth and Tax Relief Reconciliation Act of 2001 no longer distinguishes between corporate and other plan sponsors. Since then, Keogh Plans have been more commonly referred to as qualified plans by the Internal Revenue Service when they’re established by self-employed individuals.
Two Types of Keogh Plans
1. Qualified Defined-Contribution Plans
As a self-employed business owner, you can make contributions to a defined-contribution plan using either a money purchase or a profit-sharing method. For 2017, you can contribute up to $54,000 or 25 percent of your annual compensation, whichever is smaller.
Between the two options, a money purchase plan is less flexible. With this type of arrangement, you’re required to contribute a fixed percentage of income each year to the plan. Changing the percentage may trigger a tax penalty. With a profit-sharing plan, a business isn’t required to generate profits to make contributions.
2. Qualified Defined-Benefit Plans
These are similar to traditional pension plans. You determine how much you want to contribute, based on age and your expected investment return. The plan pays you a specific annual benefit in retirement, based on your salary and years of service. For 2017, you can contribute up to $215,000 or 100 percent of your annual compensation, whichever is smaller.
A defined-benefit plan may be a more appropriate choice for higher earning self-employed individuals. This type of plan does, however, tend to have higher administrative costs compared to SEP or SIMPLE IRAs, or individual 401(k) plans. They also may require additional paperwork for tax-filing purposes, making them a potentially more complicated savings option.
Keoghs and Your Taxes
Qualified-plan contributions are tax-deductible. For defined-contribution plans, the deduction maxes out at 25 percent of your annual compensation. The amount of deductible contributions for a defined-benefit plan is based on actuarial assumptions.
Qualified plans allow for penalty-free distributions beginning at age 59½. Because contributions are made with pre-tax dollars, withdrawals are taxed at your ordinary income tax rate. Like Traditional IRAs (but not Roth IRAs), you’re required to take minimum distributions from your plan beginning at age 70½. If you fail to take a required minimum distribution, you may be subject to a tax penalty equal to 50 percent of the required distribution amount.
Investing a Keogh
In terms of how you can invest your contributions, qualified plans offer many of the same investment options as other retirement plans for the self-employed. That includes stocks, bonds, mutual funds and other securities. When choosing investments in your plan, it’s important to understand the risk profile of each investment and your personal risk tolerance. As with other investments, you may want to go more conservative as you get closer to your retirement years.