A Keogh plan, a qualified scheme that caters to the self-employed, offers more significant contribution limits than conventional retirement savings programs such as the Simplified Employee Pension (SEP) or 401(k) plans. Despite the considerable administrative burden and higher upkeep costs, many high-income business owners lean towards Keogh plans due to their more extensive contribution limits. In this article, we will delve into the specifics of these contribution limits and their implications.
Understanding the Types of Keogh Plans
Keogh plans can be classified as either defined-benefit or defined-contribution plans, each with unique contribution guidelines. For clarity, the term 'Keogh plan' is rarely used in current tax retirement law context, given the lack of distinction between incorporated and self-employed plan sponsors.
As of 2013, Defined Contribution Keogh Plans permitted the employer to contribute up to 25% of income or $53,000, whichever is lower. This contribution forms the profit-sharing or money-purchase element of the plan.
Under profit-sharing plans, the setup mirrors a 401(k) scheme. It allows the employee (or owner/employee) to defer up to $18,000 or 100% of compensation, whichever is less, providing an opportunity for the employer to match this contribution. It's crucial to note that for an owner/employee bearing self-employment (FICA) taxes, the 'employer' contributions are limited to 20% of gross income/profit. With a maximum considered income of $265,000, it aligns perfectly with the potential contributions right up to the $53,000 limit.
Defined Benefit Keogh Plan
The contribution limits for a Defined Benefit Keogh Plan are complex, with the contributed amount dependent on the selected annual pension. The Economic Growth and Tax Relief Reconciliation Act of 2001 reduced the contribution limits for these plans, rendering them equally attractive as their defined-contribution counterparts but demanding more administrative efforts. Consequently, these plans have gradually lost their appeal.
Constructing and Managing a Keogh Plan
Creating a Keogh plan requires careful thought and consultation with experienced financial advisors or Certified Public Accountants (CPA). Since Keogh plans involve intricate calculations, it might be necessary to hire an actuary.
An approved prototype Keogh from a financial institution can simplify the process. However, if you are attempting to construct your own Keogh, expert consultation is strongly advised.
Remember, the Internal Revenue Service (IRS) provides a free opinion on whether your proposed plan document is acceptable, provided you have fewer than 100 employees.
Compliance and Oversight
A rigorous audit in the early 2000s reportedly found that one-third of existing Keogh plans were non-compliant with regulations. As Keogh plans are among the least understood retirement schemes, it's recommended to consult experts and the IRS before making any contributions.
While Keogh plans offer substantial contribution limits, the intricate calculations and increased administrative burden necessitate careful consideration and expert advice. However, for high-income self-employed individuals, the tax advantages and generous contribution limits can make Keogh plans a worthy choice. Always consult a financial advisor or CPA to navigate the complexities and ensure compliance with IRS regulations.
Summary
The contribution limit for a Keogh Plan depends on what type of Keogh Plan you set up. There are Defined Contribution and Defined Benefit Keoghs. Defined Contribution plans could be profit-sharing or money-purchase plans.
As of 2013, a Defined Contribution Keogh Plan allows the employer to contribute up to 25% of your income, or $53,000, whichever is less, and this will constitute the profit-sharing or money-purchase aspect of the plan.
In profit-sharing plans, they can function like a 401(k), and also include a window for the employee (or owner/employee) to defer up to $18,000 or 100% of compensation, whichever is less, and this also opens a window for the employer to include a matching contribution to the plan.
It is worth noting that for a owner/employee paying self-employment (FICA) taxes, the “employer” contributions will actually be limited to 20% of gross income/profit, but this works perfectly with the maximum considered income of $265,000, bringing possible contributions right up to the $53,000 limit.
As you can see from the profit-sharing example, multiple components can be included in a single Keogh. An experienced CPA and/or financial advisor should be consulted if you are attempting to construct your own Keogh instead of using an approved prototype Keogh from a financial institution.
In the early 2000’s, a sweeping audit of existing Keogh plans reportedly found that 1/3rd of them were not compliant with regulations. The IRS will actually give you a free opinion of whether your proposed plan document is allowable, if you have fewer than 100 employees.
Keoghs are one of the least understood types of plans, so we suggest you play it safe consult experts, and the IRS, before you contribute anything. Contribution limits of a Defined Benefit Keogh Plan are even more complicated. The amount you contribute depends on the annual pension you select.
The calculations involved in Keogh Plans are intricate and may require you to hire an actuary. The contribution limits for Defined Benefit Keogh plans were decreased in 2001 with the Economic Growth and Tax Relief Reconciliation Act, making them only as appealing as their defined-contribution counterparts, but still requiring much more administration. They subsequently have largely fallen out of favor.
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