Keogh Plans - A Robust Self-Employed Retirement Plan Opportunity

How a Keough plan can save you taxes while you save for retirement

Retirement plans for self-employed people have previously been referred to as “Keogh plans” after the law that first allowed unincorporated businesses to sponsor retirement plans. The term is used less frequently since the law no longer distinguishes between corporate and other plan sponsors. Prior to tax law changes in 2001, Keogh plans were a popular choice for self-employed people with higher incomes. 

Qualified retirement plans created by self-employed individuals are also known as Keogh Plans. Compared to the better-known 401(k) plan, an important Keogh plan benefit is potentially significantly higher contribution limits. However, greater complexity and costs associated with a Keogh Plan must also be considered.

Who Can Set Up a Keogh Plan?

Any self-employed individual, including sole proprietorships, partnerships, and unincorporated entities may establish a Keogh plan. An individual with earnings from self-employment may create and fund a Keogh Plan, even if he is also an employee elsewhere covered by a workplace retirement plan.

Keogh Plan Contribution Limits

Two different kinds of Keogh plans may be created:

  • Defined-Contribution Keogh
  • Defined-Benefit Keogh

The contribution limits for defined contribution Keogh plans are like those for SEP-IRAs; each has an annual contribution limit of 25% of net self-employment earnings, up to a maximum of $54,000 for 2017 ($53,000 for 2016).

A defined benefit Keogh plan may be designed to provide for a maximum annual retirement benefit of up to $215,000 for 2017 or 100% of compensation, whichever is lower ($210,000 for 2016). The precise amount you can contribute to a defined benefit Keogh plan depends on sophisticated actuarial calculations. The results of these calculations are influenced by your income, desired retirement benefit, anticipated length of time until retirement, and expected rate of return from investments.

Important Keogh Plan Dates

You must establish a Keogh plan by the end of the tax year for which you would like the plan to take affect. Keogh plan contributions, however, may be delayed until the tax return deadline for that year. If you file for a tax return extension, your Keogh plan contribution can also be extended until the new, extended due date of your tax return.

For most taxpayers, the above paragraph means that they must establish a Keogh plan by December 31 and make contributions by the April 15 of the following year. Furthermore, most taxpayers may extend their tax returns to as late as October 15 and thereby also receive an extension of time to fund their Keogh plans.

Keogh Plan Contribution Requirements

There are two types of defined contribution Keogh plans:

  • money purchase
  • profit-sharing

A money purchase plan requires an annual contribution if there are profits. A profit-sharing plan does not require such an annual contribution. With a profit-sharing plan, the choice to contribute is exclusively the business owner’s.

A defined benefit Keogh plan requires that the actuarially determined contribution be made each year.

Benefits of a Keogh Plan

The ability to make very large retirement plan contributions and simultaneously receive a large tax deduction are important Keogh plan benefits. Contributions to a Keogh provide a tax deduction for the tax year to which the contributions are designated.

Older, highly compensated, and affluent self-employed individuals may be particularly interested in a defined benefit Keogh. Since there are few years until retirement, potentially very large annual contributions would be required to fund the target retirement benefit. Theoretically, up to 100% of net earnings might be required to be paid into the plan, a tremendous tax saving retirement planning opportunity to those who can afford and wish to take advantage.

Disadvantages of Keogh Plans

Keogh Plans must file either Form 5500 or Form 5500-EZ every year. For a one-person defined contribution Keogh plan, this is not a major burden. However, all defined benefit Keoghs require the expense of an actuary. Self-employed individuals with no employees looking for a basic defined contribution plan are likely better-served by using a SEP-IRA, since that plan provides the benefits of a Keogh without the corresponding hassles and costs.

Updated by Scott Spann

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