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What is a Keogh plan?

The term "Keogh plan" or "HR-10 plan" has been used to describe tax-deferred pension plans specifically tailored for self-employed individuals or unincorporated businesses. Falling under the umbrella of qualified plans, Keogh plans extend to include defined-benefit and defined-contribution plans.

Types of Keogh Plans

Keogh plans are categorized into two primary types, defined-contribution plans and defined-benefit plans. Each type offers a distinct route to fund retirement for self-employed individuals or owners of unincorporated businesses.

Defined-Contribution Keogh Plans:

The defined-contribution Keogh plans could either be profit-sharing or money-purchase plans. In the case of profit-sharing Keoghs, both employee deferrals and employer contributions are incorporated. This type of plan can be repackaged as an Individual 401(k).

Defined-Benefit Keogh Plans:

In contrast, the defined-benefit Keogh plan operates as a self-funded pension. You predetermine an annual pension and subsequently calculate the necessary contributions to reach that goal. An attractive advantage is that contributions made can be deducted from your annual income. For example, a 412(e)(3) defined benefit plan could potentially allow a self-employed individual to deduct up to approximately $210,000 from their yearly income to fund their pension.

The Upsides and Downsides of Keogh Plans

Keogh plans possess several compelling features that make them popular amongst many high-income business owners. Predominantly, their higher contribution limits can act as a substantial tax shelter. However, these plans are rarely used today, given the current tax retirement laws that don't differentiate between incorporated and self-employed plan sponsors.

The administrative burdens and upkeep costs of Keogh plans are generally higher than those of Simplified Employee Pension (SEP) or 401(k) plans. The level of complexity and cost associated with the plan will largely depend on whether you opt for a prototype plan from a financial institution or build your own plan from scratch.

The Role of the IRS in Keogh Plans

The Internal Revenue Service (IRS) plays a crucial role in the functioning of Keogh plans. They set the tax-deductible contributions, which typically cap at a specific percentage of the annual income with absolute limits in U.S. dollar terms. The IRS reserves the right to modify these limits annually.

In essence, Keogh plans present an opportunity for self-employed individuals and unincorporated businesses to save for retirement while enjoying the advantages of tax-deferred growth. However, the choice between adopting a Keogh plan or opting for other retirement options like SEP or 401(k) should be driven by careful consideration of individual financial circumstances and retirement goals.

A Closer Look at the Keogh Plan

Keogh plans share similar characteristics with other retirement savings options utilized by small businesses. However, they stand out due to their specificity for self-employed individuals. The IRS refers to these plans as Keogh plans if they cover a self-employed individual. These plans can exist in any form at a sole proprietorship or partnership, broadening their appeal.

The Expanded Coverage of Keogh Plans

IRS Publication 560 categorizes workplace retirement plans into three main types: SIMPLE IRAs, SEP IRAs, and Qualified Plans. The third category, Qualified Plans, encompasses a wide variety of plans such as profit-sharing plans, 401(k)s, 403(b)s, money purchase plans, and defined benefit plans like pensions and salary continuation plans. When any of these plans are used by a sole proprietor or partnership, they fall under the domain of Keogh plans.

Weighing the Costs of Keogh Plans

While Keogh plans may provide greater retirement funding opportunities for self-employed individuals, it is essential to note that they come with additional costs. Plan administration and auditing requirements may end up significantly adding to the expenses, depending on whether the plan is designed from scratch or a prototype plan from a financial institution is used.

The Decline of the Keogh Plan

Despite the many benefits of the Keogh plan, its usage has declined in recent times. This is primarily due to the present-day tax retirement laws that no longer distinguish between incorporated and self-employed plan sponsors. As a result, the term "Keogh plan" has become less prevalent.

The Keogh plan offers self-employed individuals and owners of unincorporated businesses a tax-advantaged way to save for retirement. Its higher contribution limits and the potential to deduct contributions from annual income make it a popular choice among high-income business owners. However, with the increased administrative burdens and upkeep costs, it's crucial to balance these factors against the potential benefits before deciding to use a Keogh plan for retirement savings.

Summary:

Keogh plans are any type of qualified plan at a sole proprietorship or partnership. Keogh plans come in various forms, and this is because they are actually quite a broad category.

IRS Publication 560 (found here) divides workplace retirement plans into SIMPLE IRAs, SEP IRAs, and Qualified Plans. This last category, Qualified Plans, includes profit-sharing plans, 401(k)s, 403(b)s, money purchase plans, and defined benefit plans such as pensions and salary continuation plans.

Keogh plans, also called HR-10 plans, cover all of the above, when they are used by a sole proprietor or partnership. They have two main types: Defined Contribution and Defined Benefit. Defined Contribution Keogh Plans can either be profit-sharing, money-purchase, or combined.

How Does a 401(k) Compare With Other Retirement Plans?
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