What is the Keogh Plan?

Explanation

  • The Keogh plan, established in 1962 by Congress, is designed to give retirement benefits to professionals, self-employed persons, and unincorporated businesses. It is for those who want to contribute high to gain after retirement.The plan is approved. But the popularity of the plan is less due to other similar types of plans like SEP – IRA, 401 (k) plans, etc. The employer can select the primary type of plan from a defined contribution plan or defined benefit plan. Each type has its benefits. The withdrawals from the plan are allowed after attaining the age of 59.5 but not after the 70.5. withdrawals before the defined age are subject to tax and 10 percent penalty.

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History of Keogh Plan

  • Eugene Keogh developed this plan by establishing the Self-Employed Individuals Tax Retirement Act in 1962. Still, with the changes in the economy, the Economic Growth and Tax Relief Reconciliation Act made changes in the plan in 2001. Now this plan is recognized by the name HR 10s or qualified plans in Internal Revenue Code.It is specially designed for employees who want to contribute more for their retirement and benefits professionals like lawyers, valuers, doctors, who earn high and want to save more for their future cum retirement. The Internal Revenue Service has recognized this as a qualified plan and to give the tax benefits and retirement benefits to the self-employed.

How does it Work?

  • The plan allows the eligible persons to open the account under the Keogh Plan schemes, select the type of the plan, and start contributing pre-tax money to the plan. The plan gives the tax advantage as the contribution to the plan is not taxable, and you can withdraw after the age of 59.5 years. If withdrawals are made before the defined age, they are subject to a penalty. Still, an exception does not attract the penalty for withdrawing before the defined age.The funds of the plan invest in the stock, mutual fundsMutual FundsA mutual fund is a professionally managed investment product in which a pool of money from a group of investors is invested across assets such as equities, bonds, etcread more, bondsBondsBonds refer to the debt instruments issued by governments or corporations to acquire investors’ funds for a certain period.read more, safe securities, and other types of investments. The plan needs to be set before the end of the financial year in which deduction to be claimed. For claiming the deduction, the amount is to be contributed before the due date of filing a tax return. The money accumulated with investing gives benefits after retirement.The plan also involves some legal requirements to comply with every year, and as the fund can invest in risk-based securities, the chances of loss are also there.

Types of Keogh Plan

The following are the two basic Keogh Plan types

#1 – Defined Contribution Plan

In a defined contribution planDefined Contribution PlanA defined contribution pension plan is when the employer and the employee frequently make a significant amount of contributions to enable employees to save a decent amount of money for the retirement period and leave with the utmost dignity in their retirement phase.read more, you can contribute regularly up to a limit. There are two subtypes available in the defined contribution plan, which are as under:

  • Profit-Sharing Plan – In the Profit Sharing plan amount is to be contributed up to 25% of the profits of the business or $ 54000, whichever is lower. The amount of contribution may change every year in a profit-sharing plan.Money Purchase Plan – In a money purchase plan, the percentage of profit to be set to contribute to the plan. The percentage is fixed, and; no changes are allowed, and if changes are made in a fixed percentage, it is subject to the penalty, and like a profit-sharing plan, the amount of contribution can change every year.

#2 – Defined Benefit Plans

Under defined benefit plansDefined Benefit PlansA Defined Benefit Plan (DBP) is an employer-funded pension scheme set up to pay a pre-established amount on retirement to employees. Under this arrangement, a company takes full responsibility for planning its employees’ retirement fund. This plan offers the twin advantage of greater tax deductions to the sponsor company and a guaranteed retirement income to its employees.read more, the contributor can set the limit for the contribution to get the maximum benefit at the time or after the retirement. The contribution is subject to a higher threshold of $ 2,55,000. Both the plans allow pre-tax contributions and withdrawals are subject to the rules of the plan.

Keogh vs. IRA

  • Keogh’s plan is for sole proprietors and non-incorporated businesses. In contrast, the Individual Retirement Arrangement Plan is for self-employed and small owners with a minimum number of employees, and it does not include the non-incorporated businesses.The contributor decides the contribution limit under the Keogh plan or contribution can be flexible as based on a percentage of profits, whereas, under the individual retirement arrangement plan, the contribution is fixed at $ 6000.There is a provision for additional contribution if the age of a contributor who wants to establish an IRA is greater than 50 years. Also, under IRA, there is a double contribution provision if the contributor started contributing at the age near to retirement, but these provisions are not available under the Keogh Scheme.In the Keogh plan, legal requirements like filing of annual returns are compulsory, whereas in an IRA, there are very minimum legal requirements and no provision of annual filing.

Benefits

  • They have approved plans hence gives more reliance and satisfaction to the contributor.The contributions are flexible; one can set the limit of contribution for himself.It is beneficial for professionals, and it also includes the non-incorporated businesses.These are tax-advantageous plans and give the maximum retirement benefits.

Drawbacks

  • As the funds of the plan in risk-based securities, hence the chances of loss are more.The cost involved in managing the plan is high as compared to other plans due to more legal requirements like annual filing.Withdrawals before the defined age and change in the fixed percentage of contribution are subject to penalties.Contributions are higher as compared to other plans; hence may not be suitable for all.

Conclusion

  • Keogh Plan is the type of tax-advantageous retirement plan, unlike the other retirement plans. It is specifically for self-employed professionals, non-corporate businesses, etc. to give them retirement benefits. These are approved plans hence more reliable.The plan allows the higher contribution to get the maximum retirement benefits. The plan is different from an individual retirement arrangement plan in terms of rules, regulations, and contribution limits.It involves more legal requirements as compared to other plans as the annual filing is compulsory for this plan, which is done by an independent professional; hence the cost of the plan becomes high as compared to other plans.

This has been a guide to What is Keogh Plan & its Definition. Here we discuss the history of Keogh’s plan, types, and how it works along with the difference between Keogh vs. IRA, benefits, and drawbacks. You can learn more about from the following articles –

  • Annuity vs. Pension401k vs. Roth IRATax-Sheltered Annuity457 vs. 403b