What Is a Keogh Plan and How Does It Work?
Explore the essentials of Keogh Plans, including eligibility, structures, contributions, tax benefits, and withdrawal rules for self-employed individuals.
Keogh plans are a retirement savings option for self-employed individuals and small business owners, offering tax advantages similar to other retirement accounts. These plans allow participants to set aside substantial amounts of income for their future, making them an appealing choice for maximizing retirement savings.
Understanding Keogh plans involves examining eligibility requirements, plan structures, contribution limits, tax implications, withdrawal guidelines, and recordkeeping obligations.
Eligibility Requirements
Keogh plans are designed for self-employed individuals and small business owners operating as sole proprietors, partnerships, or unincorporated businesses. Eligible participants include those earning income from self-employment activities, such as freelance work or consulting. Corporations cannot establish Keogh plans. The business must report earned income on Schedule C or Schedule F of the tax return and must have a net profit to calculate contributions. If the business has employees, the plan must be extended to eligible employees to ensure equitable access to retirement benefits.
Plan Structures
Keogh plans offer three main structures: Defined Benefit, Money Purchase, and Profit-Sharing plans. Each option has distinct features regarding contributions, benefits, and administrative requirements.
Defined Benefit
A Defined Benefit Keogh plan guarantees a specific retirement benefit amount, calculated based on salary history and years of service. Contributions are determined actuarially, with the employer assuming the investment risk. The Internal Revenue Code (IRC) Section 415(b) caps annual benefits at $265,000 or 100% of the participant’s average compensation for their highest three consecutive years (as of 2023). This plan is ideal for those seeking predictable retirement income but requires complex actuarial assessments and adherence to funding regulations.
Money Purchase
The Money Purchase Keogh plan requires fixed annual contributions, usually a percentage of the participant’s compensation. For 2023, the contribution limit under IRC Section 415(c) is the lesser of 25% of compensation or $66,000. Participants bear the investment risk, and employers must maintain consistent contributions regardless of business profitability. This plan is well-suited for businesses with stable cash flows and those seeking a straightforward contribution structure.
Profit-Sharing
Profit-Sharing Keogh plans provide flexibility, allowing employers to adjust contributions annually based on profitability. Contributions must comply with IRC Section 415(c) limits, similar to Money Purchase plans. A predetermined formula is used to allocate contributions among participants, ensuring fairness and compliance with nondiscrimination rules. These plans are attractive for businesses that want to link retirement benefits to company performance.
Contribution Limits
Contribution limits are critical for maximizing retirement savings while avoiding penalties. For Defined Benefit plans, limits depend on actuarial calculations necessary to fund promised benefits, with a 2024 maximum benefit of $270,000. For Money Purchase and Profit-Sharing plans, 2024 limits are the lesser of 25% of compensation or $68,000. Contributions to Keogh plans are tax-deductible, providing immediate tax benefits. Adhering to these limits is essential to prevent penalties and ensure compliance.
Tax Considerations
Keogh plans offer significant tax advantages. Contributions are tax-deductible, reducing taxable income, while investments grow tax-deferred. Required minimum distributions (RMDs) must begin at age 73, with penalties for non-compliance. Proper planning can help participants minimize tax liabilities while adhering to RMD regulations.
Withdrawal Guidelines
Withdrawals from a Keogh plan are permitted without penalty starting at age 59½ and are taxed as ordinary income. Early withdrawals, before age 59½, incur a 10% penalty in addition to regular income taxes, except in specific circumstances like permanent disability. RMDs are mandatory at age 73, with a steep 50% penalty for non-compliance. Careful planning ensures withdrawals align with financial needs and tax strategies.
Recordkeeping Obligations
Keogh plans require meticulous recordkeeping to meet federal regulations. Administrators must document contributions, earnings, distributions, and plan details. For businesses with employees, additional records are needed to demonstrate compliance with nondiscrimination rules. Employers must file Form 5500 annually with the Department of Labor, detailing the plan’s financial status and operations. Inaccurate records or missed filings can result in penalties, audits, or plan disqualification. Many sponsors rely on third-party administrators or financial advisors to manage these responsibilities effectively.