What Is the Keogh Plan?
The Keogh plan is a retirement savings account available to self-employed individuals and their employees. The plan allows participants to make tax-deferred contributions and take tax-deductible distributions in retirement.
It is important to note that the Keogh plan is not a specific investment but a type of account that can be used to hold various investments. For example, Keogh's Plans can invest in stocks, bonds, mutual funds, and other types of securities.
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Understanding How the Keogh Plan Works
The Keogh plan is named after U.S. Representative Eugene Keogh initially proposed a retirement savings plan for self-employed individuals. The first Keogh plans were established in the 1960s.
The Keogh plan allows participants to make tax-deferred contributions. This means that the money contributed to the account is not subject to taxation until it is withdrawn in retirement.
Additionally, Keogh's plan distributions are taxed as ordinary income. This differs from other retirement accounts, such as a 401(k), which allows participants to take taxable distributions at a lower capital gains rate.
One downside of the Keogh plan is that distributions are taxed at a higher rate than other retirement accounts. However, the tax-deferred nature of the Keogh plan means that participants can save more money in the long run.
Types of Keogh Plans
There are two Keogh plans: Qualified Defined Contribution and Qualified Defined Benefit.
Contributions to a qualified defined contribution Keogh plan are invested and grow tax-deferred until they are withdrawn at retirement. The amount of money available at retirement depends on the account's investment performance.
While a qualified defined benefit Keogh plan, participants make tax-deferred contributions into the account. The account balance is then used to purchase an annuity, which pays out a fixed income in retirement.
The main difference between the two types of Keogh plans is how the account balance is used in retirement.
With a qualified defined contribution Keogh plan, the account balance can be withdrawn as a lump sum or used to purchase an annuity. With a qualified defined benefit Keogh plan, the account balance is used to purchase an annuity.
Second, the plan must be established by the self-employed individual or a partnership in which the individual is a partner.
Third, the Keogh plan must be established with a written trust agreement or contract. This document outlines the rules of the plan and how it will operate.
Fourth, the Keogh plan must have a designated trustee. The trustee is responsible for managing the account and ensuring that the plan's rules are followed.
Fifth, the Keogh plan must be established for the exclusive benefit of the participants and their beneficiaries.
Sixth, the Keogh plan must be registered with the IRS.
Finally, the Keogh plan must be established in the United States.
Pros and Cons of the Keogh Plan
There are both pros and cons to consider before establishing a Keogh plan.
Some of the advantages of the Keogh plan include the following:
- Tax-deferred growth - Contributions to the Keogh plan grow tax-deferred, which means that participants can save more money in the long run.
- Tax-deductible contributions - Contributions to the Keogh plan are tax-deductible, which can help reduce your overall tax liability.
There are also some disadvantages of the Keogh plan to consider:
- Higher taxes in retirement - Distributions from the Keogh plan are taxed as ordinary income, meaning that participants will pay a higher tax rate on their distributions than they would with other retirement accounts.
- Contributions are limited - The IRS limits the amount that can be contributed to a Keogh plan.
Keogh Plan vs 401(k)
The Keogh plan is similar to a 401(k) in that both are retirement savings plans that offer tax benefits.
However, there are some key differences between the two types of plans.
With a Keogh plan, participants can make tax-deductible contributions and enjoy tax-deferred growth on their investment. However, distributions from the Keogh plan are taxed as ordinary income.
With a 401(k), participants can also make tax-deductible contributions and enjoy tax-deferred growth on their investments. However, distributions from a 401(k) are typically taxed at a lower rate than distributions from a Keogh plan.
Additionally, the contribution limits for a Keogh plan are generally higher than the contribution limits for a 401(k).
The Bottom Line
The Keogh plan is a retirement savings plan that offers tax benefits to self-employed individuals and small business owners. Some rules must be met to establish a Keogh plan, and there are pros and cons to consider before doing so.
The Keogh plan may be a good retirement savings option if you're self-employed or a small business owner. However, it's essential to compare the Keogh plan to other retirement savings options, such as a 401(k), before deciding.
FAQs
1. What is a Keogh Plan?
A Keogh plan is a retirement savings plan that offers tax benefits to self-employed individuals and small business owners. Some rules must be met to establish a Keogh plan, and there are pros and cons to consider before doing so.
2. How do Keogh's plans work?
To establish a Keogh plan, the self-employed individual or small business owner must follow some rules set by the IRS. Once the plan is established, participants can make tax-deductible contributions and enjoy tax-deferred growth on their investments. However, distributions from the Keogh plan are taxed as ordinary income.
3. What are the pros and cons of a Keogh Plan?
Some of the advantages of the Keogh plan include tax-deferred growth and tax-deductible contributions. However, some disadvantages of the Keogh plan include higher taxes in retirement and limited contribution amounts.
4. How does a Keogh Plan compare to a 401(k)?
With a Keogh plan, participants can make tax-deductible contributions and enjoy tax-deferred growth on their investment, but the distributions from the Keogh plan are taxed as ordinary income. With a 401(k), participants can also make tax-deductible contributions and enjoy tax-deferred growth on their investments. Still, the 401(k) distributions are typically taxed at a lower rate than those from a Keogh plan. Additionally, the contribution limits for a Keogh plan are generally higher than the contribution limits for a 401(k).
5. Who is eligible to establish a Keogh plan?
To establish a Keogh plan, the self-employed individual or small business owner must have earned income from their business. Additionally, the business must not have any common-law employees.
