How Keogh Retirement Plans Work

Congressman Eugene Keogh (right) was a longtime champion of small business -- even very small business. Though his name no longer appears in the tax code, people still say "Keogh plan" in casual usage.
Tony Linck/Time Life Pictures/ Getty Images

Congratulations! You took the big step. Working for yourself is challenging and sometimes daunting, but it's the single best decision that you ever made. The business you started is thriving and productive. And you're quickly discovering that being self-employed means being proactive, protecting your income and planning for the future. Being the boss gives you substantial control when choosing a retirement strategy, which may include a Keogh plan.

Keoghs (or HR-10 plans) are personal, qualified, tax-deferred retirement plans for self-employed workers and small businesses. A qualified plan is one governed by section 401(a) of the tax code. Keoghs provide a source of financial security to those who do not work for traditional corporations, or for those who have a sideline of self-employment income. Keogh plans allow workers to contribute pre-tax earnings to retirement funds, where those contributions are tax deductible. Self-employed people who work for another employer can make contributions to both a Keogh plan and an IRA.


Keogh plans got their name from Eugene J. Keogh, a congressional representative from Brooklyn who sponsored the original legislation in the 1960s. He believed that the self-employed, such as doctors, artists and writers, should have the same benefit and tax advantages previously offered only under traditional, corporate pension and retirement plans.

Although Keogh plans have been around since the 1960s, they were greatly reshaped by 1982 tax code changes and a 2001 piece of legislation called the Economic Growth and Tax Relief Reconciliation Act (EGTRRA). In fact, so many things have changed that the word "Keogh" no longer appears in the tax code! If your Keogh plan existed before 2001, it's worth consulting a professional to make sure the plan still complies with the law.

A Keogh plan, like any retirement plan, has many rules and regulations. This article will help you sort through the requirements, responsibilities, and decisions you face, as well as the advantages and disadvantages of opening a Keogh.

On the next page, we explore Keogh plan rules, eligibility requirements and how to go about setting up a plan for yourself.


Keogh Retirement Plan Rules

Senior job fair
Many Americans have not saved enough for retirement. Here, an agent with Jackson Hewitt Tax Service talks with 78-year-old job-seeker Louis Brown as they peruse information on a laptop computer at a senior job fair.
Tim Boyle/Getty Images

Rules are great -- when they work in your favor, and Keogh plans have quite a few of them. Let's look at the basics.

Keoghs serve as tax shelters. You receive a deduction for the money you contribute to the plan. Taxes are also deferred as the money compounds in the plan. You don't pay taxes on the plan's earnings until you start drawing down the account -- that is, receiving payments, or distributions. At that point the payments are treated as ordinary taxable income.


Keogh plans have higher contribution limits than many other retirement plans, because you're basically contributing as both an employee and an employer. For the same reason, your FICA taxes are higher when you're self-employed.

At first glance, a Keogh's 25 percent limit seems far better than an IRA's flat $5,000 cap, or even a 401(k)'s 15 percent limit. There's a catch, though. With a Keogh, you're not contributing a percentage of annual compensation, as you would with employer-sponsored plans. You're contributing a percentage of earned income -- your self-employment income less your self-employment expenses (including the deductible 50 percent of your self-employment tax). That can set the contribution bar a bit lower, to something like 20 percent of your gross income. If your self-employment earnings are relatively small, a Keogh plan alone may not provide adequate retirement savings.

You're eligible to participate in a Keogh retirement plan if you are:

  • self-employed, a small business owner, or an active partner in an unincorporated business who performs personal services for the company
  • a sole proprietor who files Schedule C
  • in a partnership whose members file Schedule E (in this case, the partnership, not you, must establish the Keogh plan)
  • working for another company, but working for your own business as well (for example, if you're a writer with a day job and you're earning royalties on your first book, the royalties count as self-employment income)

You are not eligible to participate if you are:

  • a salaried worker for an incorporated business, with no other source of income
  • retired and not receiving compensation from a business
  • a volunteer at the business that offers the plan

To set up a Keogh, you must adopt a written plan. IRS publication 560 can help you do it, but the documentation is extensive. It's best to leave the paperwork to financial organizations such as banks, mutual fund companies, trade professionals and insurance companies. These institutions have access to "master" or "prototype" plans that the IRS has pre-approved. They also typically update these plans as the tax code changes.

If you have employees, you must notify them of the plan's contents in writing and, if they're eligible, provide them the opportunity to participate. A Keogh plan may specify a minimum age and must specify vesting requirements for participants.

If some of your employees are not co-owners of the business, their participation in the plan imposes additional restrictions on you. You probably won't be able to use a prototype plan. You'll need to follow nondiscrimination rules, which are basically ways of ensuring that plan participants' savings opportunities are proportionate and fair.

Which plan structure is right for you? How can you realize the most savings? Find the ka-CHING! on the next page.


Keogh Plan Structures and Contribution Limits

Elaine Chao
U.S. Secretary of Labor Elaine Chao listens to questions as she testifies February 6, 2002 during a hearing on the Enron collapse.
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A Keogh plan can be set up as either a defined benefit plan (structured like a traditional pension plan) or a defined contribution plan (structured more like a 401(k)).

With a defined-contribution plan, you can contribute up to 25 percent of your earned income. Defined-contribution Keogh plans can take one of two structures:


  • A profit-sharing plan gives you the flexibility to tailor your plan contributions to your business's profitability. In years when you don't make a profit, though, you can't contribute. This plan allows you to contribute varying amounts each year, make in-service withdrawals (withdrawals while you're still employed), and tax-deferred employer contributions, among other things.
  • A money-purchase plan, on the other hand, requires you to contribute when your business makes a profit. Until 2001, this type of plan had a higher contribution limit, but it now offers no savings advantage over a profit-sharing Keogh. The money-purchase plan has a fixed contribution rate. To change this amount, you would have to amend the plan document -- a complicated process.

There are paired or combination Keogh accounts that fuse elements of each account. Ask a retirement plan advisor which plan best suits the needs of your business.

Keoghs may also be set up as defined-benefit plans. A defined-benefit plan guarantees participants a set annual payment. You must calibrate your contributions to ensure that the plan will be able to provide this payment. You'll need an actuary to handle these calculations.

A defined-benefit structure can be lucrative if you're over 50 and earning a lot of money. It can be calamitous if your business' income fluctuates, because even in an unprofitable year you must still contribute to the plan.

The point of a retirement fund is that you don't touch it until retirement. If you take a plan distribution before age 59½, you can expect to pay regular income tax on the distribution, plus a 10 percent early-withdrawal penalty, at a minimum.

Depending on how you've set up your Keogh plan, it may allow certain exceptions, such as hardship withdrawals to help you pay for medical or educational expenses, or to prevent you from facing foreclosure or eviction.

If you're at least 55 and you terminate your business, you may begin receiving plan distributions without penalty. However, if your tax forms continue to show self-employment income, expect the IRS to get curious.

Once you reach retirement age, your options for plan distributions -- whether you receive them as a lump sum or as an annuity, and how your annuity is structured -- will depend on your plan document.

Is all this really better than a 401(k)? On the next page we'll look at the advantages and disadvantages of Keoghs in comparison to other types of retirement plans.


Advantages and Disadvantages of Keogh Retirement Plans

Cardin and Portman
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.


Lots More Information

Related HowStuffWorks articles

More Great Links


Altieri, Mark P. and Naegele, Richard A. "Protect Retirement Assets." AICPA Journal of Accountancy. 2008.

  • AGIS AssistGuide Information Services. "Retirement Planning." NEILL, Encyclopedia of Aging. 2008.
  • Kevles, Barbara. "Coping with Retirement." AICPA Journal of Accountancy. 1999.
  • Iowa Society of CPAs. "7 Facts You Need to Know about Keogh Plans." November 20, 2006.
  • IRS, "2008 Inflation Adjustments Widen Tax Brackets." October 18, 2007.,,id=174876,00.html
  • IRS. Publication 590.
  • Marquit, Miranda. "Self-Employed Retirement: Keogh Plan." August 18, 2006.
  • New York Life Company. "Who is Eligible for a Keogh?" 2008.
  • Oracle "Keogh Plan." 2008.
  • Orszag, Peter R., and Gale, "Whither Pensions?" William G. Web Site of the Brookings Institute.
  • Rosen, Jan M. "For Keogh Plans, a Technicality Could Crack a Nest Egg." New York Times. July 29, 2007.
  • Slesnick, Twila, and Suttle, John. Creating Your Own Retirement Plan: A Guide to Keoghs and IRAs for the Self-Employed, 2nd edition. Nolo, 2002.
  • "Are Keogh plans deductible?" 2008.