Keogh Plans are complicated to set up but good for those with good income
Self-employed persons or those with a small business could opt for Keoghs (HR-10 Plans) if they are looking for a qualified retirement plan. The plan allows you to make contributions from pre-tax earnings to your retirement funds. That makes your contributions tax deductible. Self-employed persons who work for another employer are also allowed to contribute to both an IRA and a Keogh plan.
The Plan has been modified several times over the years and it is always better that you consult a professional before setting up one.
How to set up a Keogh?
You have to adopt a written plan for setting up a Keogh plan. The IRS publication 560 is a relevant document to read though it is quite extensive. You need to take help from a financial organization to help you with the paperwork. These institutions keep prototype Keogh plan documents which would be approved by the IRS. You could notify your employees about the Keogh plan details later by yourself. But if some of your employees are not co-owners in the business then you would not be able to adopt a prototype plan.
What are the tax rules for a Keogh?
As a contributor to a Keogh, you get tax deduction for your contribution and also tax is deferred for the compounded growth of money in the Plan. You only have to pay taxes on the earnings in the account once you start withdrawing money. Then, regular income tax laws come into play.
What are the contribution limits for a Keogh?
You could set up one of the following types of Keogh Plans - defined benefit plan (structured like a traditional pension plan) or a defined contribution plan (structured more like a 401(k)).
You enjoy the highest contribution limits for a Keogh than any other retirement plan because you contribute both as an employee and as an employer. However, your FICA taxes are also higher. You don't have to contribute a percentage of annual compensation in this plan. The contributions are capped at 25 per cent limit of earned income calculated as follows: Your self-employment income less your self-employment expenses (including the deductible 50 per cent of your self-employment tax). This makes the contribution amount a bit low. It could possibly amount to only 20 per cent of your gross income. If your earnings as a self-employed person are low then Keogh savings would not be enough for your retirement.
The life expectancy of women would be 81.2 years and 75.3 years for men in 2020 which means most people would need to save for 15 years more of a retired life.
A defined-contribution Keogh plan can either be
Profit-sharing plan that allows you to decide your contributions depending upon profitability. You don't have to contribute for years you don't make a profit. You are allowed to contribute varying amounts each year and also withdraw while you are still employed. The employee contributions enjoy tax-deferred growth. But some withdrawals could incur penalties and even disqualify your Plan.
Money-purchase plan has a fixed contribution rate though you don't have to contribute when your business doesn't make profit.
Keoghs may also be set up as defined-benefit plans with guaranteed annual payment. Take help from a professional for deciding what you should be contributing to such a Plan. But you have to contribute even if your business does not make profit. This plan is good for people over 50 years of age with a good earning. But, according to the Plan document, you could make yourself eligible for simple withdrawals for medical or educational expenses.
You must start receiving distributions from your Keogh plan by April 1 of the year you turn 70 years and six months old. You are still allowed to make tax-deferred contributions.
What is the last date for setting up a Keogh Plan?
To take a deduction for contributions for a tax year, your plan must be set up (adopted) by the last day of that year (December 31 for calendar-year employers).
Contribution deadline - You can make deductible contributions for a tax year up to the due date of your return (plus extensions) for that year.