Keogh Plans: Retirement Savings for the Self-Employed

Keogh plans are retirement savings plans specifically designed for self-employed individuals and small business owners who are not incorporated. They offer a way to save for retirement while enjoying tax advantages similar to those offered by traditional 401(k)s and IRAs.

Types of Keogh Plans

There are two main types of Keogh plans:

• Defined Contribution Keogh: This type allows you to contribute a certain percentage of your net self-employment income each year. The amount you can contribute varies depending on the specific plan type, but generally, you can contribute up to 25% of your net adjusted self-employment income. Examples of defined contribution Keogh plans include money purchase plans and profit-sharing plans.
• Defined Benefit Keogh: This type guarantees a specific retirement benefit based on factors like salary and years of service. These plans are often more complex to administer and are generally better suited for older self-employed individuals who want to maximize their retirement savings in a shorter period. The annual contribution is determined by an actuary and can be significantly higher than with a defined contribution plan.

Contribution Limits and Tax Advantages

One of the biggest advantages of a Keogh plan is the potential for high contribution limits. For defined contribution Keogh plans, the contribution limit is capped annually. For 2024, the limit is $69,000. For defined benefit Keogh plans, the calculation is more complex, but the goal is to fund the promised retirement benefit. Contributions to a Keogh plan are typically tax-deductible, reducing your current taxable income. Earnings within the Keogh plan grow tax-deferred until retirement, at which point distributions are taxed as ordinary income.

Eligibility and Setting Up a Keogh Plan

To be eligible for a Keogh plan, you must be self-employed or own a small business that is not incorporated. You will need to establish the plan with a financial institution, such as a brokerage firm, bank, or insurance company. The process involves completing paperwork, choosing investments, and adhering to specific IRS regulations.

Considerations Before Opening a Keogh Plan

Before establishing a Keogh plan, it’s important to consider the following:

• Net Self-Employment Income: Your contribution limit is based on your net self-employment income, so ensure you have enough income to make meaningful contributions.
• Administrative Costs: Defined benefit Keogh plans, in particular, can have higher administrative costs than other retirement plans.
• Investment Choices: Choose investments that align with your risk tolerance and retirement goals.
• Compliance: Adhere to IRS rules and regulations to avoid penalties. Consulting with a financial advisor is highly recommended.
• Alternative Options: Explore other retirement savings options like SEP IRAs and SIMPLE IRAs to determine which plan best suits your needs. A solo 401(k) might also be a better choice depending on individual circumstances.

Keogh plans can be a powerful tool for self-employed individuals seeking to build a secure retirement nest egg. By understanding the different types, contribution limits, and tax advantages, you can make an informed decision about whether a Keogh plan is the right choice for you.