What Is an HR 10 Plan and How Does It Work?
Explore the essentials of HR 10 plans, their types, contribution rules, tax benefits, and withdrawal guidelines for self-employed individuals.
HR 10 plans, commonly known as Keogh plans, provide self-employed individuals and small business owners with a tax-advantaged way to save for retirement. They are particularly valuable for those lacking access to traditional employer-sponsored retirement options like 401(k)s.
Eligible Individuals
HR 10 plans are designed for self-employed individuals and small business owners. Eligibility requires self-employment income from sources like sole proprietorships, partnerships, or LLCs, reported on Schedule C or Schedule F of IRS Form 1040. Independent contractors, such as freelance graphic designers, also qualify. Small business owners with employees can establish these plans but must include eligible employees, as mandated by the Employee Retirement Income Security Act (ERISA). Employees aged 21 or older who have completed one year of service must be allowed to participate.
Contributions must be based on net earnings from self-employment after deducting business expenses and self-employment tax, ensuring they stem from legitimate business income.
Types of HR 10 Plans
HR 10 plans offer several options, each tailored to the needs of self-employed individuals and small business owners.
Defined Benefit
A defined benefit HR 10 plan guarantees a specific retirement benefit amount based on a formula involving salary history and years of service. Similar to traditional pensions, these plans require contributions calculated by an actuary to ensure future obligations are met. The maximum annual benefit is the lesser of $230,000 or 100% of the participant’s average compensation for their highest three consecutive years (as of 2023). These plans are ideal for those seeking predictable retirement income but require consistent, often substantial contributions.
Money Purchase
Money purchase HR 10 plans mandate fixed annual contributions, set as a percentage of compensation. The contribution limit is the lesser of 25% of compensation or $66,000 (as of 2023). For example, a self-employed consultant earning $200,000 annually could contribute up to $50,000. While this plan ensures steady retirement savings, its rigidity can be challenging during years of lower business income.
Profit-Sharing
Profit-sharing HR 10 plans provide flexibility, allowing business owners to adjust contributions annually based on profitability. The maximum contribution is the lesser of 25% of compensation or $66,000 (as of 2023). This flexibility makes them appealing to businesses with variable income. For example, a business owner might contribute the maximum in a profitable year but reduce contributions during leaner times. These plans must comply with ERISA’s nondiscrimination rules to ensure contributions are equitable.
Contribution Rules
Contribution rules for HR 10 plans are structured to maintain fairness and maximize tax benefits. Defined benefit plans require contributions based on actuarial calculations to meet promised retirement benefits. Money purchase and profit-sharing plans allow contributions up to 25% of compensation, capped at $68,000 for the 2024 tax year.
Contributions must be made by the tax return filing deadline, including extensions, giving business owners time to evaluate their finances. ERISA’s nondiscrimination requirements ensure contributions are fair for all eligible employees.
Tax Treatment
HR 10 plans offer significant tax advantages. Contributions are generally tax-deductible, lowering taxable income for the year. This deduction is governed by IRC Section 404, which outlines the applicable limits and qualifications.
The tax-deferred growth of investments within the plan further enhances its value. Earnings are not taxed until withdrawn, allowing for compounding over time. For instance, a $50,000 annual contribution to a profit-sharing plan with a 7% average annual return can grow substantially over decades compared to a taxable account.
Withdrawals and Penalties
Withdrawals from HR 10 plans are taxed as ordinary income in the year they are taken. Early withdrawals before age 59½ typically incur a 10% penalty in addition to income tax, as outlined under IRC Section 72(t). Exceptions include permanent disability or qualified medical expenses exceeding 7.5% of adjusted gross income (AGI). Another exception is taking substantially equal periodic payments (SEPP), though strict adherence to the rules is required.
Required minimum distributions (RMDs) must begin by April 1 of the year after the participant turns 73 (as of 2023, under the SECURE 2.0 Act). Failure to take RMDs results in a penalty of 25% of the amount not withdrawn, which can be reduced to 10% if corrected promptly.
Reporting Requirements
HR 10 plans involve detailed reporting obligations to ensure compliance with IRS and Department of Labor (DOL) regulations. Plan administrators must file IRS Form 5500 annually for plans with assets exceeding $250,000, detailing the plan’s financial status and operations. Failure to file can lead to significant penalties.
Contributions must be accurately reported as deductions on Schedule C or Schedule F, while distributions are reported as taxable income on Form 1040. For plans with employees, employers must perform nondiscrimination testing and issue Form 1099-R for distributions. Compliance with these requirements is critical to avoid penalties or plan disqualification.
Maintaining accurate records and seeking professional assistance when necessary can help ensure the plan remains in good standing and meets all legal obligations.