A Self-Employment Retirement Plan, often referred to as a Keogh Plan, is a tax-deferred pension plan that caters specifically to self-employed individuals and small business owners. Established under the Self-Employed Individuals Tax Retirement Act of 1962, these plans provide a robust solution for retirement savings, offering significant tax advantages and flexible contribution limits.
Types of Keogh Plans
Defined Contribution Plans
Defined Contribution Keogh Plans allow for a fixed annual contribution up to a specified limit. The primary difference lies in how contributions are made:
- Profit-Sharing Plans: Contributions are made as a portion of the earnings or profits of the business. The contribution limit is 25% of the compensation or $61,000 (2022), whichever is less.
- Money Purchase Plans: These require a fixed percentage of the business’s income to be contributed each year, up to 25% of the earned income or $61,000 (2022).
Defined Benefit Plans
Defined Benefit Keogh Plans promise a specified benefit at retirement, often calculated based on factors such as salary history and duration of employment. These plans can provide higher contributions than defined contribution plans, up to a maximum annual benefit of $245,000 (2022).
Contributions and Tax Advantages
Contributions made to Keogh Plans are tax-deductible, thereby lowering taxable income. Earnings in the plan grow tax-deferred until withdrawals are made at retirement, which is then taxed as ordinary income. This is a significant advantage as it allows the investments to compound over time without being eroded by taxes.
Special Considerations
Eligibility
To establish a Keogh Plan, an individual must have self-employment income, which includes sole proprietorships, partnerships, and limited liability companies (LLCs). The rules mandate that if an employer implements a Keogh Plan, all eligible employees must be included.
Compliance and Regulations
Keogh Plans are subject to specific rules and regulations, including annual reporting and disclosure requirements as dictated by the Internal Revenue Service (IRS) and the Employee Retirement Income Security Act (ERISA). Regular compliance review is necessary to ensure adherence to these regulations.
Historical Context
The Keogh Plan was named after U.S. Representative Eugene Keogh who championed the tax advantages for self-employed individuals. The plan’s roots date back to the Self-Employed Individuals Tax Retirement Act of 1962, reflecting a legislative effort to extend retirement savings opportunities beyond traditional employment settings.
Applicability and Comparisons
Applicability
Keogh Plans are suitable for self-employed individuals and small business owners seeking to leverage tax benefits while planning for retirement. They are particularly useful for those with higher income potential due to the generous contribution limits.
Comparisons with Other Plans
- SEP IRA: Both allow for high contribution limits but Keogh Plans offer more flexibility with different plan types.
- Solo 401(k): Often preferred for simplicity and ease of establishment, they also offer high contribution limits but lack the defined benefit option.
Related Terms
- SEP IRA: A Simplified Employee Pension Individual Retirement Account for self-employed individuals.
- Solo 401(k): A retirement plan for self-employed individuals with no employees.
- Tax-Deferred: Earnings such as interest, dividends, or capital gains that accumulate tax-free until the investor takes withdrawal.
FAQs
What is the maximum contribution limit for a Keogh Plan?
Who is eligible for a Keogh Plan?
Are contributions to a Keogh Plan tax-deductible?
Summary
Keogh Plans provide a versatile and tax-advantaged solution for self-employed individuals and small business owners planning for retirement. With both defined contribution and defined benefit options, these plans offer significant flexibility and potentially higher contribution limits compared to other retirement plans.
