Keogh Plan vs. SEP IRA: What’s the Difference?

Retirement planning for self-employed individuals and small business owners involves navigating a unique set of options. Among the historical and current choices, Keogh plans and Simplified Employee Pension (SEP) IRAs represent two distinct approaches to saving for the future. While both were designed to serve businesses outside the large corporate structure, they differ significantly in their complexity, contribution rules, and administrative requirements.

Defining the Keogh Plan

A Keogh plan is a tax-deferred retirement plan for self-employed individuals and unincorporated businesses. Historically, they were a primary vehicle for sole proprietors and partnerships. Keogh plans fall into two categories: defined-contribution, where contributions are specified, and defined-benefit, which promise a specific annual payout at retirement. Defined-contribution Keoghs could be profit-sharing plans with flexible contributions or money purchase pension plans with fixed annual contributions.

The term “Keogh plan” is now largely outdated. Legislation in 2001 standardized the rules for corporate and non-corporate retirement plans, eliminating the special distinctions that defined Keogh plans. The Internal Revenue Service (IRS) now groups them into the broader category of “qualified plans.”

As a result, the structures once unique to Keoghs are now available to any business. For a self-employed individual with no employees, the Solo 401(k) has emerged as the modern successor to the Keogh. It incorporates features like higher contribution limits and the potential for participant loans within a framework aligned with current regulations.

Understanding the SEP IRA

A Simplified Employee Pension (SEP) IRA allows employers to make retirement contributions for themselves and their employees. Its primary feature is administrative simplicity, with a minimal setup process that often requires only IRS Form 5305-SEP. Under a SEP IRA, the employer establishes and contributes to a traditional IRA for each eligible employee, where funds grow tax-deferred.

Only the employer makes contributions; employees cannot contribute via salary deferrals as they might in a 401(k). If a contribution is made, it must be applied uniformly to all eligible employees, meaning each receives the same percentage of their compensation. A key benefit is that there are no annual filing requirements for the employer.

Key Comparative Factors

Contribution Rules

For a SEP IRA, an employer can contribute up to 25% of an employee’s compensation, capped at $69,000 for 2024 and $70,000 for 2025. For the self-employed, this calculation is based on net adjusted self-employment income, which works out to a 20% contribution rate. The employer can decide each year whether to contribute and can vary the percentage, as long as it is uniform for all participants.

Qualified plans, including the types formerly called Keoghs, have more varied rules. A profit-sharing plan offers flexibility similar to a SEP IRA, while a money purchase pension plan requires a fixed annual contribution. A defined-benefit plan uses a formula to fund a specific retirement benefit, which for 2024 can be as high as $275,000, but this involves significant actuarial and administrative costs.

Administrative Burden

The administrative requirements for SEP IRAs are minimal. There are no annual IRS reporting requirements for the employer, such as the Form 5500 series. This lack of annual filings reduces ongoing administrative tasks and costs.

In contrast, qualified plans, including former Keogh types, carry a heavier administrative load. These plans require a formal written plan document and are subject to the Employee Retirement Income Security Act (ERISA), which imposes fiduciary and reporting standards. Most of these plans must file a Form 5500-series return with the IRS annually. For a one-person plan, a Form 5500-EZ is required once plan assets exceed $250,000, while plans with employees file either Form 5500-SF or the full Form 5500.

Plan Loan Availability

SEP IRAs do not permit plan loans. Funds are held in a traditional IRA, and any early withdrawal is a taxable distribution, potentially subject to a 10% penalty if the participant is under age 59½. This restriction removes a source of liquidity for the business owner or employees.

Qualified plans, on the other hand, can be designed to allow participant loans. This feature allows a participant to borrow a portion of their vested account balance, up to $50,000. The loan must be repaid with interest over a set period, usually five years, providing access to funds without triggering taxes and penalties.

Employee Inclusion

For a SEP IRA, an employer must cover any employee who is at least 21, has worked for the business in at least three of the last five years, and earned minimum compensation. This “three of five” rule is often more inclusive of part-time employees. If a contribution is made for anyone, all eligible employees must receive one.

Qualified plans have different standards. A common requirement is one year of service, defined as working at least 1,000 hours in a 12-month period. Plans may extend this to two years of service, which comes with faster vesting requirements, and can allow for the exclusion of more part-time employees than a SEP IRA.

Choosing a Plan for Your Business Structure

For a sole proprietor or small business owner who values ease of administration and flexible contributions, the SEP IRA is a suitable choice. Its straightforward setup and lack of annual reporting make it a low-maintenance option for those who do not need features like plan loans.

The SEP IRA is well-suited for businesses with few or no employees where the goal is to maximize employer contributions simply. The flexibility to skip contributions is beneficial for businesses with fluctuating income, as there is no penalty for skipping a contribution in a lean year.

An individual seeking features like plan loans or the ability to make both employee and employer contributions would now look to a Solo 401(k). This plan is for a self-employed individual with no employees (other than a spouse) and combines high contribution limits with greater flexibility. A Solo 401(k) allows the owner to contribute as both “employee” and “employer,” and can include a loan provision, making it the modern equivalent for those with needs beyond a SEP IRA.