A Keogh plan is a tax-deferred retirement plan used for self-employed or unincorporated businesses. A Keogh plan can be set up as a defined benefit or a defined-contribution plan, with the latter being the most common. Contributions are mostly tax deductible up to a certain percentage of annual income, with absolute limits in US dollars that can be changed by the Internal Revenue Service (IRS) from year to year.
Although the IRS refers to Keogh plans as “HR 10” many people continue to use the original term. Technically, “Keogh” is no longer relevant; while it used to refer only to self-employment plans, the law no longer differentiates between corporate plan sponsors and other plans. Your Keogh plan, like an IRA, can hold stocks, bonds, mutual funds, and certificates of deposit.
It can established by self-employed people and those who work for them. Keogh plans are available to small businesses, partnerships, limited liability companies (LLCs), and sole proprietorships. Keogh plans are still used today, but their popularity has declined, with individual/single 401(k)s and SEP IRAs rising to the top of the list of retirement plan options.
Keogh plans have more administrative burdens and higher maintenance costs than SEP or 401(k) plans. Still, the contribution limits are higher, making plans a good option for many high-income business owners.
Because current tax laws do not distinguish between incorporated and self-employed plan sponsors, the term “Keogh plan” is not commonly used.
1.Keogh Plans Structure
Keogh plans can be defined as defined benefit plans that guarantee a specific retirement income. However, the majority are defined contribution plans, which do not provide an income guarantee but allow employees to contribute a percentage of their earnings. The following are the most common Keogh plans:
-Profit sharing plans:
This type of defined contribution plan allows businesses to contribute the lesser of 25% of their compensation or $58,000 in 2021 ($61,000 in 2022). This annual maximum for those 50 and older is $64,500 in 2021 ($67,500 in 2022).
These are similar to profit-sharing plans in that companies must make annual contributions regardless of whether the business makes a profit. In 2021, they had the same contribution limit of the lesser of 25% of compensation or $58,000 (plus a $6,500 catch-up contribution for workers over 50).
-Qualified defined benefit plans:
These provide retirees with a guaranteed annual benefit based on the employee’s years of service. The maximum annual benefit for 2021 is the lesser of 100% of employee pay or $230,000.
2.How Do Keogh Plans Work?
The IRS classifies Keogh plans as qualified plans and divides them into two types:
Defined-contribution plans and defined-benefit plans (also known as HR(10) plans). Keogh plans, like 401(k)s and IRAs, can invest in the same types of securities as 401(k)s and IRAs, such as stocks, bonds, certificates of deposit (CDs), and annuities.
In a defined contribution plan, specify how much money you want to put into the fund each year. The amount can be determined in two ways: profit-sharing (your company is the only one who pays into it) or money purchasing (you contribute a fixed amount of your income every year into the plan).
A money-purchase plan allows you to decide how much of your profits you want to put into a Keogh from the start. The contribution limit is set in stone and cannot be changed. The money-purchase plan has the same limitations as the profit-sharing plan: $61,000 in 2022 ($58,000 in 2021), or 100% of compensation, whichever is less.
Defined benefit plans operate similarly to traditional pension plans in that you set and fund a retirement goal for yourself. Your annual benefit cannot exceed 100% of your average compensation over the previous three calendar years, or $245,000 in 2022 ($230,000 in 2021), whichever is less.
3.Pros and Cons of a Keogh Plan
Keogh plans offer several advantages to self-employed individuals. Their contribution limits are higher, so more money is deposited into the account. This may be especially advantageous for older, high-income earners. Keogh plans provide tax-favored retirement savings to small business owners and some employees. Employers in small businesses may also deduct contributions made on behalf of their employees.
However, as reasonably complex financial tools, Keogh’s plans do pose some challenges. They frequently necessitate the services of tax and financial advisors to handle the massive amount of paperwork involved. Hiring a professional is another step a taxpayer can take to ensure that all numbers and calculations are correct.
Keogh plans also necessitate more maintenance than SEP, simple IRAs, or 401(k) plans, which means these costs can add up. Furthermore, specific plans will require you to make contributions each year to meet a minimum funding standard. Even if you’re on a tight budget, this still applies.