Having a comfortable retirement is something we all hope for, but it can be more challenging to attain when you are financially responsible for yourself.
Americans are quitting the workforce in large numbers. Gallup reports that 34 percent of the working population is in the independent business sector. One of the most difficult tasks for the self-employed is opening a retirement account. A 2019 survey by Transamerica found that U.S. citizens do not save nearly enough.
It can be difficult to figure out how to save for retirement when you’re on your own, but a Keogh plan is one option that doesn’t get as much attention as 401(k)s.
How Do Keogh Plans Work?
New York State Assemblyman Eugene Keogh (KEE-oh) developed the Self-Employed Individuals Tax Retirement Act of 1962, also known as the Keogh plan. It was the first government initiative specifically designed to provide tax breaks to people who work for themselves while also encouraging retirement savings.
For highly compensated sole proprietors, a Keogh plan offers a tax-deferred retirement savings option. Until the Economic Growth and Tax Relief Reconciliation Act of 2001, self-employed taxpayers had no other option for retirement savings than this.
As of right now, these programs are known as qualified retirement plans or “H.R. plans” by the IRS, who have decided that the phrase is now officially out of date. 10″, but many people continue to refer to them as Keogh plans.
Mutual funds, equities, bonds, and CDs are all acceptable investments in a Keogh plan, which is a type of retirement savings account similar to an individual retirement account (IRA) or company retirement plan (401(k). The good news is that, like a 401(k) plan, donations to an IRA are tax-deductible up to a specific percentage of an individual’s income. But the IRS changes the restrictions every year.
Different Types of Keogh Plans
Keogh plans can be established as either defined benefit plans or defined contribution plans.
Defined Benefit Plans
A defined benefit plan is an option if the promise of a certain amount of money each month in retirement appeals to you. This is somewhat similar to pension plans, in which retirees get a set amount each month.
The amount of money you receive once you’ve reached retirement age is up to you. Say you’re interested in a monthly income of $1,000. Then, think about when you want to retire and how much you want to save annually to get you there.
Like typical pension plans, a Keogh plan with a defined benefit structure will provide a specific amount of money to beneficiaries each year.
Definition of Contribution Plans
Defined contribution plans are the most prevalent kind of Keogh plan. Your retirement income is not guaranteed, but you can put away a set percentage of your earnings each year.
Your company can contribute to a defined contribution plan like a profit-sharing arrangement, or one of the numerous others. You can also employ a practice known as “money purchasing,” in which you put away a set amount annually.
The Keogh plan is similar to a typical IRA or 401(k) in that it can be accessed after retirement.
How Does a Keogh Plan Operate?
A Keogh plan can only be initiated by select individuals. You must be a solo proprietor or operate as a sole proprietorship. Check with your tax advisor whether your business structure is a partnership or LLC to see if you qualify.
Any financial institution, such as a bank, brokerage, or mutual fund business, will accept your application for an account. You can have the money for your account deducted automatically, before taxes, from your paycheck on a regular basis.
Various financial instruments, including equities, bonds, mutual funds, and exchange-traded funds, are available for you to choose from when deciding where to put your money (ETFs).
A Keogh Plan is a type of qualified retirement plan that functions similarly to a 401(k). You can make contributions with after-tax dollars, and they’ll still be deducted from your taxable income.
In a Keogh account, you won’t have to worry about paying taxes on interest, dividends, or capital gains until you take the money. When you reach retirement age and begin withdrawing funds, however, you will owe taxes.
Limitation on Keogh Plan Contributions
Keogh plans are fantastic because of their high contribution limits, which allow high-income self-employed people to make up for a lost time in their retirement savings.
For instance, in 2022, if you establish a defined contribution plan, you can put away up to 25% of your salary. A catch-up provision allows those 50 and older to contribute an additional $67,500 in 2022.
A defined benefit plan, in which you will get a regular payment after retirement, allows for substantially larger contributions. The potential for donations is practically limitless.
In 2022, you can contribute up to the IRS maximum of $245,000. Contributions to a Keogh plan are deducted before taxes are calculated. With a contribution of $25,000, an individual with $345,000 in income would only owe taxes on $100,000.
This has a particularly dramatic effect on your taxable income if you’re a high-earner. People who are self-employed are those who are their own bosses and who run their own businesses.
Rules for Keogh Plan Withdrawals
The Keogh Plan withdrawal rates are comparable to 401(k) plan withdrawal rates. The minimum withdrawal age is 59 and 12. There is a 10% penalty for early distributions, and your state may impose further penalties.
The Internal Revenue Service (IRS) explicitly forbids hardship withdrawals from a Keogh plan, which is subject to stringent hardship withdrawal requirements. At age 59 12, early withdrawal fees are waived. There is no mandated withdrawal age of 70 and 12, however.
Pros of the Keogh Plan
Keogh plans, which let huge contributions be made tax-free, may be especially useful for helping retirees who fell behind on their savings get back on track.
- Massive Investments Keogh plans to allow for far larger investments than other retirement vehicles such as IRAs. People of a higher income bracket and senior citizens will benefit from this. By contrast, in 2022, IRA contributions are capped at $6,000 while contributions to a defined contribution Keogh plan can go as high as $61,000.
- Retirement account contributions may be deducted from your taxable income, providing a substantial benefit to those in the highest tax brackets. A lower tax burden, more money saved for retirement, and higher potential profits are all possible results of this strategy.
- Limitless Investment Opportunities. a 401(k) plan participant is limited to the fund options provided by the employer. Nonetheless, under this scheme, you get to pick the assets yourself.
- For those who, like the majority of Americans, have not yet saved enough for retirement, now is the time to open a Keogh plan or an Individual Retirement Account (IRA). You can finally get back on track with your retirement savings.
Cons with the Keogh Plan
The Keogh plan has some difficulties, including the need to file an annual report to the IRS describing the fund’s operations and the fact that it is only offered to a small number of people.
- In order to qualify for this plan, you must be a self-employed business owner. One must be self-employed in order to participate in a Keogh plan; employees are ineligible. If you’re going to be working for yourself, you’ll have to foot the bill for your own health insurance and Social Security.
- Constant Paperwork. There is a lot of paperwork and red tape involved in setting up a Keogh plan for an organization. There is a legal requirement to file a plan with the government, and the Internal Revenue Service (IRS) wants to see specifics regarding the investments and tactics you intend to use. If the paperwork is not submitted each year, you may face serious consequences.
- Expensive to Maintain Because of the volume of documentation involved in maintaining this plan, it is recommended that a professional administrator be retained, such as an attorney or an accountant. Numerous specifics ought to be incorporated into your strategy.
- The Internal Revenue Service Conducts Audits of the Following Pension Plans. Any changes to the tax code will necessitate revisions to the plan document. And the IRS does conduct audits of these plans, so you’ll want to keep yours up-to-date with any changes in tax law.
Because of the extra work involved in maintaining a Keogh plan, it is not as widely discussed in the media as simpler retirement options like a Roth IRA or standard IRA.
Due to the high contribution limitations, however, this plan is particularly attractive to those who are self-employed, operate as a single proprietorship, or run a small business. This choice should be part of your financial strategy if you are well-off and can spare some funds for savings.