Keogh Plan vs. SEP IRA: Key Differences

Keogh plans and Simplified Employee Pension (SEP) IRAs are retirement plans tailored for self-employed individuals and small business owners. Both provide a way to save for retirement with tax-deferred growth and offer higher contribution limits than standard individual retirement accounts (IRAs). While they share this common goal, they possess differences in their structure, contribution rules, and administrative requirements. The term “Keogh plan” is an older designation, now formally referred to by the IRS as a qualified plan. Understanding these distinctions is important for selecting the plan that best aligns with a business’s financial situation.

Eligibility and Plan Establishment

SEP IRAs are available to almost any type of business, including sole proprietorships, partnerships, LLCs, S-corporations, and C-corporations. They are straightforward to set up, often requiring only the completion of Form 5305-SEP or a prototype plan from a financial institution.

Keogh plans are traditionally associated with unincorporated businesses, such as sole proprietorships and partnerships. The term describes qualified plans like profit-sharing or money purchase plans established by these entities. A modern version of a Keogh-type plan for a business with no employees other than the owner (and spouse) is the Solo 401(k), which is more complex to establish than a SEP IRA.

An operational difference lies in the deadlines for establishing each plan. A business owner can set up and fund a SEP IRA for a specific tax year up until their business’s tax filing deadline for that year, including extensions. This provides considerable flexibility, allowing a business to make the decision to establish a plan well after the close of the tax year. In contrast, a Keogh plan must be formally established by the end of the tax year, which is December 31 for most businesses, even though contributions can be made later.

Contribution Rules and Limits

SEP IRAs are funded exclusively by employer contributions. The business owner, acting as the employer, contributes to the SEP IRA of each eligible employee, including themselves. These contributions are discretionary, meaning the employer can choose to contribute a different amount or nothing at all each year, offering flexibility.

Keogh plans offer more variety in their contribution structure. They can be set up as profit-sharing plans, which also allow for discretionary employer contributions. Alternatively, they can be established as money purchase pension plans, which require a fixed, mandatory employer contribution each year. This lack of flexibility can be a drawback for businesses with fluctuating income.

For both plan types, annual contributions are limited to a percentage of compensation, which is the lesser of 25% of compensation or $70,000. For a self-employed individual, compensation is defined as net adjusted self-employment income. This figure is calculated by taking gross self-employment earnings, subtracting one-half of the self-employment taxes paid, and then subtracting the retirement plan contribution itself.

An advantage of certain Keogh plans, specifically the Solo 401(k), is the ability to allow for both employee and employer contributions. As an “employee,” the business owner can make elective deferrals up to the annual limit of $23,500. On top of that, the owner, as the “employer,” can make a profit-sharing contribution. This dual-contribution structure can allow for significantly higher total contributions at lower income levels compared to a SEP IRA, which only permits the employer portion. The deadline for making contributions to both plan types is the business’s tax filing deadline, including extensions.

Administrative and Reporting Duties

The ongoing management responsibilities for SEP IRAs and Keogh plans are different. For a business owner with a SEP IRA, there is no annual filing requirement with the IRS. This lack of reporting reduces the administrative burden and potential costs associated with maintaining the plan.

Keogh plans, as qualified plans, fall under the Employee Retirement Income Security Act of 1974 (ERISA). This subjects them to more stringent rules and reporting requirements. Once total assets in a Keogh plan exceed $250,000, the plan administrator is required to file an annual report with the IRS on a Form 5500-series document.

Preparing and filing Form 5500 can be complex and may require the assistance of a third-party administrator or tax professional, adding to the overall cost. ERISA regulations also impose fiduciary responsibilities on the plan administrator, which involves acting in the best interest of all plan participants.

Key Differentiating Features

One of the most significant features distinguishing these plans is the ability to take a loan. Keogh plans can be designed to permit participants to borrow against their vested account balance. The loan amount is limited to the lesser of $50,000 or 50% of the vested account balance and must be repaid with interest over five years.

This loan feature is unavailable with SEP IRAs. Because a SEP plan is built on individual retirement accounts (IRAs), any loan would be treated as a taxable distribution and subject to a 10% early withdrawal penalty. For a business owner who values potential access to retirement funds for short-term needs, the loan provision of a Keogh plan is an advantage.

Another distinction involves the availability of Roth contributions. While traditional SEP IRAs only allow for pre-tax employer contributions, some Keogh plans, like the Solo 401(k), can be structured to accept Roth employee contributions. These after-tax contributions do not provide a current-year tax deduction but allow for tax-free qualified withdrawals in retirement.

Investment options are not a major point of differentiation, as both plan types allow for a wide array of investments through a brokerage account.