Chances are, you don’t say Keogh plan anymore – even if you have one. Not only can it be tough to pronounce (hint: it’s KEY-oh), the term is antiquated. Even the Internal Revenue Service calls them “Qualified Plans” instead of the more traditional name. It’s true: you can’t even find the word Keogh in the Internal Revenue Code (go ahead, click on over to section 401(a) – you won’t see it).
Keogh plans, or H.R.10 plans, were named after Rep. Eugene James Keogh (D-NY) who sponsored the original legislation. Keogh plans were pitched as retirement plans for the self-employed, generally higher-earning professionals, and were officially signed into law in 1962. They’ve been tweaked repeatedly over the years with the most important changes happening in 1982 and 2001.
Today, Keogh plans can be divided into two basic kinds: defined-contribution plans and defined-benefit plans.
Defined-contribution plans can be broken down further into two types:
- Profit-sharing plan (PSP). The title of the PSP is a little bit misleading. The business doesn’t actually have to show a book profit. The term is used because the contribution is discretionary from year to year: you can choose to contribute up to 25% of compensation or $51,000 for 2013 and $52,000 for 2014.
- Money purchase plan (MPP). An MPP plan is less flexible and requires you to contribute a fixed percentage of income every year up to 25% of compensation. If you alter the percentage of an MPP, you can be subject to a penalty.
A defined benefit plan is a bit more complicated. It’s easiest to think of it as a self-funded pension plan. You can contribute up to $205,000 for 2013 ($210,000 for 2014) – or up to 100% of your compensation – which makes it an attractive vehicle for those in higher income brackets. The actual funding formula is set up based on a calculation from IRS – and it can get pretty complicated.
In fact, complexity is one of the main drawbacks for Keogh plans overall. They lack the simplicity of a traditional individual retirement account (IRA), 401(k), or a SIMPLE IRA. A lack of flexibility in some Keogh variations can also be a problem: you may be required to make a contribution even when you aren’t so flush. Keoghs are also considered to be audit targets (I haven’t seen this in my practice but anecdotally, compliance for Keoghs has been a concern).
In exchange for the potential lack of flexibility and degree of complexity, contribution limits are significantly higher. That pay-off is considered worth it for some, especially older, high-income earners. Additionally, Keogh plans still allow for contributions to a traditional or Roth IRA in some circumstances.
As with most retirement plans, contributions to Keogh plans are made with pre-tax dollars: there’s no post-tax “Roth” equivalent with a Keogh. For tax purposes, that means you can take a deduction for the contribution but you will pay tax on withdrawals. And as with other retirement plans, penalties may be imposed for early withdrawals (some hardship exceptions may apply).
