Keogh Plan Rules
If you’re self employed you may want to consider a
Keogh retirement plan. Here’s a look at the common
Keogh plan rules.
The Keogh plan, named after New York Ex-Congressman Eugene Keogh, is a retirement plan created
for self-employed workers and unincorporated small businesses (limited liability companies are eligible
to establish a Keogh plan). Even employed workers with self-employment income are allowed to create
and contribute to a Keogh plan.
Like other qualified retirement plans, contributions made to a Keogh plan are tax-deductible.
Contributions and earnings on your contributions aren’t taxed until you withdraw the money.
Establishing a Keogh Plan
The Keogh must be established via a written plan by the end of the tax year for which it is effective.
Financial institutions, insurance companies, and some professional organizations have prototype plans
that have already been approved by the IRS. A business can create their own plan and have it approved
by the IRS, though IRS approval isn’t necessary. Having a prototype plan from a company may be more
beneficial because banks and insurance companies typically update their plans as necessary when tax
It’s important that a Keogh plan continues to abide by tax law. If the IRS audits the plan and finds that it’s
not compliant with the law, previous contributions may be declared non-tax deductible. That could result
in a tax bill for previous years.
Though the Keogh plan must be established by the end of the calendar year, contributions can be made
up until the tax deadline including the tax extension, if one is filed. For example, a Keogh for 2011 must
be established by December 31, but contributions can be made until April 17, 2012.
Defined-Benefit Plan vs. Defined-Contribution Plan
Keogh plan rules must specify which type of plan will be created. There are two basic types of Keogh
plans: defined-benefit plans and defined-contribution plans.
With defined-benefit plans, the employer decides the specific benefit employees should receive during
retirement and makes annual contributions based on that amount. A calculation must be done to decide
how much should be contributed each year. With this type of plan, employers are required to make
annual contributions based on the calculation.
A defined-contribution plan allows the employer to
determine the exact amount to contribute to employee
accounts each year. Employers can choose the
profit-sharing plan where have a contribution amount
that varies each year. The employer can choose to make
a contribution only when the company makes a profit.
Any year the employer contributes to his own account, he
must also contribute to his employees’ accounts. The
Keogh plan must specify a method of calculating
employee contributions, e.g. based on years of service,
age, or some other factor.
The alternate defined-contribution plan is the
money-purchase plan where there’s a fixed contribution
amount required each year, even when there is no profit. If the employer doesn’t make the required
contribution, there’s a tax penalty. To change the contribution amount, the employer has to amend their
Contributions are capped at 25% of earned income up to $49,000. These contribution limits can change
each year, based on IRS guidelines. Earned income is income after business deductions and self-
employment tax and is often lower than gross income which is what’s used with many other types of
Though employees do not make their own contributions, they must be allowed to participate in the plan.
The employer makes entire contributions on the employee’s behalf.
Penalty-free withdrawals from a Keogh plan can’t be made until the employee reaches age 59 ½. Any
withdrawals made before that age are subject to a 10% penalty unless there’s an exception:
- The account owner is suddenly disabled
- Medical expenses exceed 7.5% of the employee’s gross income
- The employee is at least 55 and leaves the company or terminates the business
The IRS requires any employee that owns more than 5% of the company to begin taking required
minimum distributions (RMD) starting at age 70 ½. Failure to take withdraw the minimum amount will
result in a 50% excess accumulation penalty.
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