Keogh Plans

A Keogh or HR 10 plan is a tax-deferred retirement savings plan for self-employed individuals. It works much like any qualified plan such as defined benefit, money purchase, or profit sharing plans. Keoghs were very limited when first enacted in 1963 but they provided a much needed option for self-employed persons to save for retirement. Keoghs can be either a defined contribution or a defined benefit plan and the maximum amount of contribution depends upon which plan you have.

Sole proprietorships or partnerships are eligible to participate in a Keogh plan. These persons are not technically considered employees and some significant special rules for self-employed individuals covered under the plan are indicated. The most important special rule is the definition of earned income.

Earned income is defined as the self-employed individual’s net income from the business after all deductions, including the deduction for the Keogh plan contribution.1

There are several advantages to a Keogh plan:

• contributions are deducted from the gross income
  
• tax is deferred until the funds are withdrawn
  
• interest income generated is tax deferred until withdrawn
  
• certain lump sum benefits might be eligible for special 10-year averaging
  
• contribution limits are more liberal than IRAs.

There are also several disadvantages to a Keogh plan:

• plan involves all the costs and complexities associated with qualified plans
  
• the same early withdrawal penalties of other qualified plans applies
  
• if the participant is a more then 5% owner, payments must begin by April 1 of the year after reaching 70-1/2 whether or not the participant has retired.

Any type of qualified plan can be designed to cover self-employed persons. Usually, a profit sharing or money purchase plan is chosen to cover one self-employed person and possibly the spouse. A self employed person can also establish a 401(k) plan but matching contributions are not treated as elective employer contributions and are not subject to the annual limit.

You can find more information about Keogh plans from your financial institution or insurance company. The IRS Publication 560 has some very good information on Keogh plans and is updated annually.