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How Keogh Retirement Plans Work


Advantages and Disadvantages of Keogh Retirement Plans
If you like high contribution limits, be grateful to these guys (Benjamin L. Cardin, D-Md., and Rob Portman, R-Ohio), who introduced the pension-reform legislation that became part of EGTRRA in 2001.
If you like high contribution limits, be grateful to these guys (Benjamin L. Cardin, D-Md., and Rob Portman, R-Ohio), who introduced the pension-reform legislation that became part of EGTRRA in 2001.
Scott J. Ferrell/Congressional Quarterly/Getty Images

What do you stand to gain from a Keogh plan? They're tailored to the self-employed, who typically have a higher tax burden than people who work for other corporations. For that reason, tax is deferred until you withdraw the funds. You typically don't pay any taxes on the plan itself. And like all tax-exempt retirement plans, it's protected from creditors by federal bankruptcy law.

Your contributions to a Keogh plan are deducted from your gross income rather than your net income. They also have generous contribution limits. If you're under age 50, in 2008, an employer-sponsored 401(k) allows you to contribute up to $15,500 of your pay. A SIMPLE or SIMPLE 401(k) allows up to $10,500. A traditional or Roth IRA allows you contribute up to $5,000. By contrast, a Keogh allows you to contribute up to 25 percent of your earned income.

But just like anything else, there are disadvantages, too.

  • If you want to establish a retirement plan now so that you can deduct contributions for the tax year that just ended, a Keogh won't work. A SEP is your only option.
  • The same early-withdrawal fees and penalties apply to Keoghs as to any other qualified plan. If you think you'll need your savings before age 59½, you may be better off with a savings vehicle like a long-term CD or a Roth IRA.
  • You must start receiving distributions from the plan by April 1 of the year you turn 70½. You may, however, continue to make tax-deferred contributions.
  • If your Keogh has -- or has ever had -- more than $100,000 in assets, you must file a Form 5500 or 5500-EZ.
  • You must establish a vesting schedule for the plan -- a schedule under which you're entitled to a percentage of your benefit only after a certain length of time. If you need more flexibility in your savings, a Keogh may not be for you.
  • As the tax code changes, you must update your plan document. That's a major responsibility. You may want to work with a professional -- which could add administrative costs -- or choose a SEP, which offers similar contribution limits but less responsibility.

The IRS has been auditing more Keogh plans. By some estimates, as many one-third of these plans are noncompliant [source: Rosen]. If your plan is found to be noncompliant, none of your contributions are tax-deductible. That means your taxable income for the applicable years will be higher, and you'll owe back taxes as well as interest and late-payment penalties.

The retirement plan that's right for you depends on many factors, including whether you have employees, how much you expect to earn, how old you are and how comfortable you are with plan administration and tax forms. You can learn more by following the links on the next page.