For countless Americans chasing the self-employed lifestyle, building a business often overshadows the critical task of securing a solid retirement nest egg. Traditional employer-backed retirement schemes frequently remain off-limits to freelancers and independent entrepreneurs—this is precisely where the Keogh plan steps into the limelight.
Known in financial circles as the KEY-oh, a Keogh plan is essentially a tax-deferred retirement vehicle tailored for self-employed earners and unincorporated ventures like sole proprietorships and LLCs.
Although officially rebranded by the IRS as “H.R. 10 plans” or “Qualified Plans for Self-Employed Individuals,” the legacy name “Keogh” endures, a nod to the legislator who championed the laws that brought them into existence.
While Keogh plans can echo the mechanics of pensions, profit-sharing arrangements, or 401(k)s, their intricacy often demands support from specialists such as actuaries, tax gurus, and financial consultants. When it comes to highly compensated solo practitioners, these plans can sometimes be the smartest fit.
Let’s delve deeper into the nuances of how Keogh plans tick and explore vital considerations if you’re mulling over this retirement tool.
How Keogh Plans Tick: A Structural Breakdown
Keogh retirement options fall under two principal umbrellas: defined benefit plans and defined contribution plans. Both vehicles shelter retirement savings from taxes while allowing growth, but each comes bundled with distinct IRS protocols, structural setups, and ideal candidates. Here’s a snapshot.
Defined Benefit Plans: Predictability Meets Planning
This setup resembles a traditional pension where your annual retirement payout is tied to your prior earnings, typically averaging your top three consecutive salary years. The pension benefit doesn’t grow without bounds — it’s capped, with 2024’s ceiling set at $275,000 or 100% of your earnings, whichever falls lower.
Quarterly payments usually fund the plan, and minimum funding thresholds apply. Pinpointing the exact maximum deductions and contributions calls for expert financial guidance.
Even if you’re the sole plan participant, these schemes are beasts to manage. The IRS emphasizes the necessity of ongoing professional involvement for actuarial math and other technical duties essential to compliance and fund adequacy.
Defined Contribution Plans: Flexibility Anchored to Contributions
These fall into two camps: profit-sharing and money purchase pension plans. Benefits hinge strictly on how much cash flows into your account. For 2024, deductions max out at 25% of compensation plus elective salary deferrals. Employer contributions top out at $69,000 or 25% of pay, whichever is less.
- Profit-sharing plans: Offer adaptability with employer contributions—they can fluctuate yearly and might even dip to zero.
- Money purchase pension plans: Demand fixed contributions regardless of business profits. For instance, if your plan mandates a 15% salary contribution, you’ll owe it even in lean years.
Did you know? According to IRS data, in 2022 approximately 5 million Americans were covered by defined benefit plans, but participation has steadily declined over the past two decades as defined contribution plans gained popularity.
Who Qualifies for a Keogh Plan?
Primarily, these plans shine brightest for sole proprietors pulling in substantial income. Yet, many high-earning solopreneurs find other options like SEP IRAs and solo 401(k)s offer greater ease and flexibility.
If you’re flying solo in your business, establishing a Keogh plan with yourself as the lone participant is feasible. Conversely, small business owners must adhere to IRS minimum participant thresholds, often linked to a proportion of the workforce size.
Contribution Caps: How Much Can You Stash Away?
Elective deferrals, when permitted by the plan, can reach $23,000 for 2024—with catch-up contributions bumping that higher for those aged 50 and above.
Keogh Plans Versus 401(k)s: What Sets Them Apart?
Both Keoghs and 401(k)s operate as tax-advantaged retirement vehicles, yet they diverge sharply in several respects:
- Contribution Limits: Defined benefit Keoghs escape contribution ceilings, unlike 401(k)s which cap at $22,500 (plus $7,500 catch-up for 50+ in 2024). Total combined limits including employer match for 401(k)s hit $69,000 or $76,500 for older participants.
- Who Puts In the Money: Keogh plans predominantly rely on employer-only contributions. Employee input may be possible but isn’t tax deductible for participants—only for the business. This setup often means consulting IRS deduction worksheets and tax pros. In contrast, 401(k)s welcome contributions from both parties, with employer matches common but not guaranteed.
- Set-up and Upkeep: Keoghs are known for their complexity, often requiring specialized expertise to establish and maintain. 401(k)s enjoy wider acceptance and streamlined servicing through numerous financial institutions.
- Regulatory Framework: Due to their dual nature encompassing both defined benefit and defined contribution types, Keogh plans face a tangled web of IRS regulations, whereas 401(k)s usually benefit from greater simplicity and uniformity.
Final Thoughts: Is a Keogh Plan Your Retirement Ally?
For most one-person businesses, retirement vehicles like SEP IRAs or solo 401(k)s hit the sweet spot for ease and efficiency. However, if you command a high income and intend to carve out a pension-like benefit, a defined benefit Keogh plan could be a strategic choice. Brace yourself, though, for steeper administrative demands and more labyrinthine IRS paperwork.
Whichever path beckons, kicking off your retirement planning journey with seasoned financial and tax advisors will be your safest bet.