Definition
The Self-Employment Individuals Retirement Act, better known as the Keogh Plan, is a tax-advantaged, retirement savings plan designed primarily for small business owners and self-employed individuals. Named after U.S. Representative Eugene Keogh, who sponsored the legislation, Keogh Plans allow eligible individuals to set aside a portion of their income for retirement. Contributions to a Keogh Plan are tax-deductible up to certain limits, providing both immediate tax relief and long-term savings growth benefits.
Examples
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Sole Proprietor Contribution: A sole proprietor of a small consultancy firm opens a Keogh Plan and decides to contribute a portion of their annual income. If their earnings are $100,000, they might contribute $20,000 to the plan, which is tax-deductible, reducing their taxable income for that year.
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Partnership Contribution: A partnership consisting of two doctors decides to set up a Keogh Plan. Each partner’s earnings are considered separately, and each can contribute $15,000 of their $120,000 annual income to their respective Keogh Plans, thus achieving tax-deferred growth.
Frequently Asked Questions (FAQs)
1. What are the types of Keogh Plans available?
- There are two main types of Keogh Plans: Defined Benefit Plans and Defined Contribution Plans. Defined Contribution Plans can be further categorized into Money Purchase Plans and Profit-Sharing Plans.
2. Who is eligible to set up a Keogh Plan?
- Self-employed individuals such as sole proprietors, partnerships, and unincorporated businesses are eligible to establish a Keogh Plan.
3. What are the contribution limits for a Keogh Plan?
- Contribution limits for Keogh Plans vary with the type of plan chosen. For Defined Contribution Plans, individuals can contribute up to 25% of their compensation or $58,000 (for 2021), whichever is less.
4. Can employees participate in a Keogh Plan?
- Yes, if the self-employed individual has employees, they must include eligible employees in the plan, making contributions for them as well.
5. What are the tax advantages of a Keogh Plan?
- Contributions made to a Keogh Plan are tax-deductible, reducing taxable income for the year they are made. The funds in the plan grow tax-deferred until withdrawn.
Related Terms
- IRA (Individual Retirement Account): A retirement savings account with tax advantages, available to individuals with earned income.
- 401(k) Plan: A retirement savings plan sponsored by an employer that allows employees to save and invest a portion of their paycheck before taxes are taken out.
- SEP (Simplified Employee Pension) IRA: A retirement plan that an employer or a self-employed individual can establish, with contributions made directly to an individual retirement account (IRA) set up for each employee.
- Defined Benefit Plan: A retirement plan that guarantees a specified benefit upon retirement, often based on salary and years of service.
Online References
Suggested Books for Further Studies
- “The New Retirement Savings Time Bomb” by Ed Slott
- “Retirement Planning Guidebook” by William J. Bernstein
- “ESOPs and Retirees: Benefits of Employee Ownership Plans” by Scott Barnes
Accounting Basics: “Keogh Plan” Fundamentals Quiz
### What is the primary purpose of a Keogh Plan?
- [x] To provide retirement savings for self-employed individuals and small business owners.
- [ ] To offer health insurance to employees.
- [ ] To save for a child's education.
- [ ] To invest in real estate properties.
> **Explanation:** The primary purpose of a Keogh Plan is to provide retirement savings for self-employed individuals and small business owners with tax-deferred contributions.
### Can Keogh Plan contributions be made with after-tax dollars?
- [ ] Yes.
- [x] No.
- [ ] Sometimes.
- [ ] Only for partnerships.
> **Explanation:** Keogh Plan contributions are made with pre-tax dollars, meaning they are tax-deductible, which reduces the taxable income for the year the contributions are made.
### Who primarily benefits from setting up a Keogh Plan?
- [ ] Corporations
- [x] Self-employed individuals and small business owners
- [ ] Retired professionals
- [ ] High school students
> **Explanation:** Keogh Plans are designed to benefit self-employed individuals and small business owners by allowing them to make tax-deferred retirement contributions.
### What type of Keogh Plan allows for a specific annual benefit amount at retirement?
- [x] Defined Benefit Plan
- [ ] Defined Contribution Plan
- [ ] SEP IRA
- [ ] Traditional IRA
> **Explanation:** A Defined Benefit Plan allows for a specific annual benefit amount at retirement, which is usually based on salary and years of service.
### What is the contribution limit for a Keogh Plan in 2021?
- [ ] $19,500
- [ ] $26,000
- [x] $58,000
- [ ] 25% of compensation
> **Explanation:** For Defined Contribution Plans, individuals can contribute up to 25% of their compensation or $58,000 (for 2021), whichever is less.
### Must employees be included in a Keogh Plan if the business has any?
- [x] Yes
- [ ] No
- [ ] Only if they have worked for more than 5 years
- [ ] Only full-time employees need to be included
> **Explanation:** If the business has employees, they must be included in the Keogh Plan, and contributions must be made for eligible employees.
### When are the funds in a Keogh Plan taxed?
- [ ] Immediately upon contribution
- [ ] Every 5 years
- [x] Upon withdrawal
- [ ] They are not taxed
> **Explanation:** The funds in a Keogh Plan grow on a tax-deferred basis and are taxed only upon withdrawal.
### What legislation led to the creation of the Keogh Plan?
- [ ] ERISA
- [x] Self-Employment Retirement Act of 1962
- [ ] Pension Protection Act
- [ ] Sarbanes-Oxley Act
> **Explanation:** The Self-Employment Retirement Act of 1962, sponsored by U.S. Representative Eugene Keogh, led to the creation of the Keogh Plan.
### Can a Keogh Plan be rolled over into an IRA?
- [x] Yes.
- [ ] No.
- [ ] Only specific types of IRA.
- [ ] Not until a holding period of 10 years.
> **Explanation:** A Keogh Plan can be rolled over into another tax-advantaged retirement account such as an Individual Retirement Account (IRA).
### Is there a penalty for early withdrawal from a Keogh Plan?
- [x] Yes, generally a 10% penalty.
- [ ] No, there are no penalties.
- [ ] Only after age 72.
- [ ] It depends on the defined benefit amount.
> **Explanation:** Early withdrawals from a Keogh Plan generally incur a 10% penalty, in addition to the applicable income taxes.
Thank you for exploring the intricate details of Keogh Plans through our comprehensive guide and challenging quiz questions. Empower your retirement planning with extensive knowledge!
