Legal Definitions - Keogh plan

A Keogh plan, also known as a qualified retirement plan or H.R. 10 plan, is a type of retirement savings account specifically designed for self-employed individuals and owners of unincorporated businesses. These plans allow eligible individuals to save for retirement with significant tax advantages, similar to how 401(k)s or IRAs work for employees of larger companies.

The primary benefits of a Keogh plan include:

• Tax-Deferred Growth: Contributions and investment earnings within the plan grow without being taxed until the funds are withdrawn in retirement.
• Tax-Deductible Contributions: Contributions made to a Keogh plan are typically tax-deductible in the year they are made, which can reduce your current taxable income.
• Contribution Limits: There are annual limits on how much can be contributed, which are generally higher than those for individual IRAs, allowing for substantial retirement savings.
• Withdrawal Rules: Like other retirement accounts, funds generally cannot be withdrawn without penalty before age 59½. Withdrawals typically become mandatory once the account holder reaches age 72. Early withdrawals may be subject to a 10% penalty in addition to regular income taxes.

Keogh plans come in two main forms:

• Defined Contribution Keogh Plan: In this type, you or your business contribute a set amount or percentage of income each year. Your retirement benefit will depend on the total contributions made over time and how well the investments perform.
• Defined Benefit Keogh Plan: This type aims to provide a specific, predetermined retirement income. Annual contributions are calculated by an actuary to ensure there will be enough money in the plan to meet that future income goal.

While the term "Keogh plan" is still understood, the Internal Revenue Service (IRS) and financial professionals now more commonly refer to these as qualified retirement plans or H.R. 10 plans.

Examples of Keogh Plans in Action:

• Example 1: A Freelance Web Developer

  Maria is a self-employed web developer who works independently for various clients. She wants to save for her retirement and reduce her annual tax bill. She decides to open a defined contribution Keogh plan. Each year, she contributes a percentage of her net self-employment income to the plan. These contributions are tax-deductible, lowering her taxable income for the year, and the money she invests grows tax-free until she retires and begins making withdrawals.

  This example illustrates how a self-employed individual can use a Keogh plan to save for retirement while benefiting from tax deductions and tax-deferred growth.

• Example 2: A Small Business Owner with Employees

  Dr. Chen owns a small veterinary clinic structured as a sole proprietorship, employing two veterinary technicians. He wants to save for his own retirement and also provide a retirement benefit for his employees. Dr. Chen establishes a defined contribution Keogh plan for himself and his staff. He contributes a portion of his own earnings to his account and also makes contributions on behalf of his employees based on their salaries. All contributions are tax-deductible for the business, and the funds grow tax-deferred for everyone involved.

  This example demonstrates that Keogh plans can cover not only the self-employed business owner but also their eligible employees, offering a retirement savings solution for small, unincorporated businesses.

• Example 3: An Independent Financial Consultant Planning for a Fixed Retirement Income

  David is an independent financial consultant who has consistently high earnings and wants to ensure he receives a specific, predictable annual income during his retirement, regardless of future market performance. He chooses to set up a defined benefit Keogh plan. An actuary calculates the substantial annual contributions David needs to make to his plan to guarantee his desired retirement payout. This allows him to contribute a larger amount than he might to a defined contribution plan, securing a fixed income stream for his golden years.

  This example highlights the "defined benefit" structure of a Keogh plan, where the focus is on achieving a predetermined retirement income, often allowing for higher contributions for those with significant earnings.