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An Introduction To The Keogh Retirement Plan

Denise Appleby

Self-employed individuals who want to set up retirement plans for their businesses may choose an IRA-based retirement plan such as SEP IRA or choose a Keogh plan. In this article, we focus on the Keogh plan and provide a high-level overview.

Keogh Defined
A Keogh, also known as an H.R.10 plan, is a qualified retirement plan that can be adopted and maintained by a self-employed individual (a sole proprietor, a partner in a partnership or certain fishermen). The term "Keogh" is rarely used by financial institutions and financial professionals these days. As such, self-employed individuals who want to establish such a plan would ask about a defined benefit plan or a defined contribution plan for the self-employed. The options for defined contribution plans include money purchase pension plans, profit sharing plans and 401(k) plans.

Features and Benefits Determine Suitability
A self-employed individual who wants to adopt a Keogh should consider the features and benefits of each option, and choose the one that is most suitable.The contribution rules and the cost of maintaining the plan are often the most important features. The following are highlights of the contribution rules.

Defined Benefit Defined Contribution
Money Purchase Pension Profit Sharing 401(k)
Contribution amount Usually the amount required to provide an annual benefit that is no more than the smaller of $205,000 or 100% of the individual’s average compensation for his or her highest three consecutive calendar years. The lesser of 100% of eligible compensation or $51,000. The lesser of 100% of eligible compensation or $51,000. Salary deferral 100% of compensation up to $17,500, plus an additional $5,500 for individuals who are at least age 50 by the end of the year.
A profit sharing and a 401(k) can be combined. In such cases, the contribution is limited to the lesser of 100% of eligible compensation or $51,000, plus an additional $5,500 for individuals who are at least age 50 by the end of the year. The salary deferral limit applies.
Are contributions mandatory or discretionary? Mandatory Mandatory Usually discretionary Discretionary (can choose whether to defer each year)
Deduction amount Amount based on actuarial calculations and assumptions. 25% of eligible compensation 25% of eligible compensation 25% of eligible compensation
Contributions for a self-employed individual are based on the individual’s modified net business income. The IRS provides a special worksheet that can be used to calculate contributions for self-employed individuals. This worksheet is available in IRS Publication 560 at www.irs.gov.

Roth 401(k) Feature
If allowed under the plan, a Roth 401(k) feature can be added if the plan is a 401(k) plan. Salary deferral contributions can be made to the traditional and Roth 401(k) accounts, or split between both. The aggregate salary deferral contributions must not exceed $17,500, plus an additional $5,500 for individuals who are at least age 50 by the end of the year. Roth 401(k) salary deferral contributions and rollovers from other Roth 401(k) or Roth 403(b) accounts are the only types of contributions that can be made to Roth 401(k) accounts.

Administrative Requirements

Establishing the Plan
A self-employed individual establishes a qualified plan by completing the adoption agreement by the end of the year. Once the adoption agreement is completed, it covers the plan for as long as it is maintained. Amendments to the adoption agreement may be required if the self-employed individual wants to make changes to the elective features, and/or if amendments are needed to adopt regulatory and other mandatory changes.

Contributions are usually required to be made by the individual's tax filing due date, plus extensions, unless an exception applies. For instance, contributions to defined benefit plans may need to be made on a quarterly basis, within 15 days after the end of each quarter

5500 Filing
If plan assets are more than $250,000 at the end of the year, Form 5500-EZ, or Form 5500-SF if filed electronically, should be filed for the plan.

If the plan allows, loans can be taken, providing the amount does not exceed the lesser of $50,000 or 50% of the plan balance.

Investing Plan Assets
Once contributions are made to the plan, they are usually invested according to the self-employed individual’s investment profile - often with the assistance and guidance of a competent financial advisor. For defined benefit plans, actuarial projections may affect the design of the investment portfolio.

Portability Rules
Assets can be rolled over from other retirement accounts, allowing the self-employed individual to consolidate his or her retirement savings. The following are caveats for rollover to the plan:

  • After-tax amounts cannot be rolled over from a traditional IRA.
  • Roth IRAs cannot be rolled over.
  • If after-tax amounts are being rolled over from another qualified plan or 403(b), the transaction must be done as a direct rollover.

If the rollover amounts are accounted for separately from other plan assets, the plan can allow those amounts to be withdrawn without any restriction. The terms of the plan document will dictate when withdrawals can be made from other plan assets.

Choosing the Right Type of Plan
Cost and complexity and two of the primary features often taken into consideration when choosing a qualified plan. Defined benefit plans are the most costly to fund and maintain. This is not only because contribution limits are the highest and are mandatory, but also because the services of actuaries and third-party administrators are required to ensure the plans are maintained in compliance with regulatory requirements.

The discretionary contribution feature of the profit sharing plan is often an attractive feature for self-employed individuals, as it allows them to choose each year whether they want to make contributions to the plan.

The Bottom Line
Self-employed individuals should consult with a professional who is an expert in the area of qualified plans, for assistance in ensuring that the plan chosen is the most suitable, as well as to ensure that the plan is maintained in accordance with the terms of the plan document and regulatory requirements.

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