Definition
A Keogh Plan is a tax-deferred pension plan available to self-employed individuals or unincorporated businesses for retirement purposes. It allows a contributor to deposit pre-tax dollars into the plan, which can then grow tax-free until withdrawal. The contribution limit for a Keogh Plan is significant, permitting individuals to save more than standard Individual Retirement Accounts (IRAs).
Key Takeaways
- A Keogh Plan is a tax-deferred pension plan available to self-employed individuals or unincorporated businesses for retirement purposes.
- Contributions to a Keogh Plan are tax-deductible, providing a useful tax shelter for eligible individuals, and earnings and interest accrued within the plan are also tax-deferred until withdrawal.
- There are two types of Keogh Plans – defined benefit and defined contribution plans. Defined Benefit Keoghs focus on the ultimate benefits that will be received at retirement, while Defined Contribution Keoghs focus on the annual contribution to be made to the account.
Importance
The Keogh Plan, also known as a qualified tax plan, is a significant financial term as it provides small business owners and self-employed individuals with a facilitated mechanism to save for their retirement along with substantial tax benefits.
This pension plan allows these individuals to make tax-deductible contributions, which grow tax-deferred until withdrawal.
The ability to save more compared to other retirement plans like IRAs, due to higher contribution limits, gives the Keogh Plan singular importance.
Additionally, it also offers flexibility with its two plan options: defined benefit and defined contribution plans.
Therefore, the Keogh Plan is of vital importance in financial planning for self-employed taxpayers.
Explanation
The Keogh Plan serves a notable purpose mainly for self-employed individuals or those who own unincorporated businesses, such as partnerships or proprietorships. It stands as a tax-advantaged pension plan, allowing these individuals to take part in retirement savings at a higher contribution limit than most other types of retirement plans.
Essentially, the Keogh Plan is a vehicle for the self-employed to create their personalized retirement programs, fostering the infusion of cash into both high-deductible defined benefit plans and profit-sharing plans leading to significant tax savings. This leads us to the functionality aspect of the Keogh Plan.
Total contributions to a Keogh Plan can either be up to 25% of compensation or $58,000 for 2021 (whichever is less), providing a convenient gateway to preserve larger amounts of income compared to other plans like the IRA or 401(k). In other words, it’s a tax shelter used to stretch the tax advantages over a substantial amount of earnings. The funds in the plan grow tax-deferred until they are withdrawn.
But, it’s important to note that, like many retirement plans, early withdrawal before 59½ can lead to heavy tax penalties.
Examples of Keogh Plan
Small Business Retirement Savings: A local small bookstore owner has operated her business for several years. She has no employees apart from herself and wants to establish a retirement account. She sets up a Keogh plan that allows her to contribute pretax income towards her future retirement needs.
Consultation Firm: A management consultant operates his own firm and has a number of employees. He establishes a Keogh Plan not only for himself but also for his employees. This allows him to provide a retirement benefit to his team and also save on his own taxes, as the contributions to the plan are tax-deductible.
Self-Employed Physician: A self-employed doctor working out of her own practice decides to start a Keogh plan to set aside a portion of her income without having to pay taxes on it upfront. This benefits her in the long term when she retires, as the funds will then be taxed at her then-current tax rate, which is expected to be lower than her current rate.
FAQs about Keogh Plan
1. What is a Keogh Plan?
A Keogh Plan is a tax-deferred pension plan available to self-employed individuals or unincorporated businesses for retirement purposes. Named after Congressman Eugene Keogh, it allows a contributor to contribute up to 25% of their income, up to an annual limit, which can be tax-deductible.
2. How can one set up a Keogh Plan?
Setting up a Keogh Plan involves several steps. You must first establish your plan before the end of your fiscal year, then determine your annual contributions, and finally, complete certain Internal Revenue Service (IRS) paperwork. One can also hire a financial planner to help with setting up the plan.
3. Are there any drawbacks to a Keogh Plan?
Keogh Plans can be more complicated to set up and maintain than other retirement plans due to their complex tax reporting requirements. Moreover, they may not be suitable for all businesses, in particular those with fluctuating income, because the amount one must contribute can change from year to year.
4. How does a Keogh Plan differ from a 401(k)?
A Keogh Plan is mostly designed for self-employed individuals and allows for greater contributions than a 401(k). Conversely, a 401(k) is an employer-sponsored plan and comes with both traditional and Roth options, whereas a Keogh Plan does not.
5. Can I withdraw from my Keogh Plan before retirement age?
Yes, but there will be penalties for early withdrawal. If you withdraw from your Keogh Plan before age 59.5, you may be subject to a 10% early withdrawal penalty in addition to income taxes you’d owe.
Related Entrepreneurship Terms
- Retirement Account
- Self-Employed Plan
- 401(k) Plan
- Individual Retirement Account (IRA)
- Tax-deferred Contributions
Sources for More Information
- Internal Revenue Service (IRS): The IRS is the U.S. government agency responsible for tax collection and tax law enforcement. It offers detailed information about the rules and regulations regarding Keogh Plans.
- Investopedia: Investopedia is a leading source of financial content on the web, with more than 30 million unique visitors and 90 million page views each month. It has a comprehensive article about Keogh Plans.
- Fidelity Investments: Fidelity is an international provider of financial services and investment resources. It provides educational content on a wide range of financial topics, including Keogh Plans.
- Charles Schwab Corporation: Charles Schwab is a bank and stock brokerage firm based in the U.S. It provides insights on different types of retirement plans including Keogh Plans.
