Why Are Keogh Plans Still Worthwhile

One of the biggest mistakes that business owners make is not thinking about retirement. They think that once they’ve left the corporate world that there’s really no way to get anything done, and that’s not the case at all. If that really were the case, there would definitely be a pretty big revolt. You shouldn’t feel like you have to work for a company just to keep your retirement going. There are actually a few different types of retirement plans out there for you to check out.

Let’s take on the Keogh retirement plan today.

You might not have heard too much about the Keogh plan, but it’s still a viable tool for retirement. Since we’re talking about the self employed here, you should know that this retirement plan is specifically directed at self-employed workers and even small business owners.

The plan takes its name from Congressman Eugene J. Keogh, who championed the original legislation. He believed that everyone should have access to building a nest egg — not just people traditionally employed. This can be jarring for someone in modern times to realize just how “modern” it really is to be able to put away for retirement when you don’t work for anyone but yourself.

What makes Keoghs so powerful is that it still allows you to contribute pre-tax earnings, and those contributions are tax-deductible. If you are self-employed and you still work for another employer, you can make contributions to both the Keogh plan (self-employment income) as well as the IRA account that we all know and love.

Like other retirement vehicles, you do get to enjoy watching your money grow tax-deferred, and you don’t pay taxes on the money that you sock away in a Keogh. This is a nice tax shelter that can really help you keep more of your money in your pocket rather than the IRS’s pocket. Now, when we say things like this here in our guides, people immediately believe that we’re trying to say that you have access to the money. That’s not the case at all, but a bit of perspective is in order.

If you did nothing with the money at all, you would still have to pay taxes on the money to the IRS. Why not make sure that the money works for you as long and as hard as it can before you have to pay Uncle Sam? That’s really the best way to go. If you just let your money waste away, you won’t have the money when it’s time to really do great things during the retirement era.

The nice part about Keogh plans is that you have a very high contribution limit — 25% of your earned income. This would be your self-employment income with your expenses taken out. Keep in mind this includes the 50% of your self-employment tax that is deductible. This can make your contribution bar a bit lower than you might expect, but it all evens out in the end.

So, how do we turn on those benefits? Well, you could always create your own written plan to start a Keogh, but that’s intense even for the fiscally wise among us. It’s better to leave the documentation requirements to a bank or a mutual fund company. Not only will you be able to start sooner, you will also avoid having to update all of that paperwork on your own when there are changes in the tax code — and trust us, there are always changes in the tax code!

Now, if you are just a solopreneur working on your own, you don’t have too much to think about. However, when you add employees to the soup things really do get thick — and thick means complicated. You have to notify each and every employee in writing about the contents of the plan, as well as the information on how to participate if they are indeed eligible. There can be a minimum age requirement as well as specific vesting requirements for the participants.

Here’s a little more information, just to round things out: you can actually set up a Keogh plan in two different ways. You can set it up as a defined benefit plan, or a defined contribution plan. If these terms seem familiar, it’s because they are very much reminiscent of traditional pension plans and 401(k)s.

With the defined contribution plan, you can put away up to 25 percent of your earned income. The best way to go is a profit-sharing plan (a subset of the defined contribution plan) that basically gives you the power to contribute only when you make a profit. If you only make a little bit of profit, you don’t have to make big contributions. This gives a growing company the ability to make real decisions about their retirement-oriented affairs.

Keep in mind that you will still not be able to withdraw from your retirement plan without penalty until you are 59 1/2 years old. If you break the rules you will have to pay a 10% penalty as well as regular income tax on the distribution. Ouch. This can be pretty costly.

Does that mean that you should avoid it completely? No, absolutely not. You might want to wait until the start of the next tax year in order to get your Keogh benefits from a tax perspective.

There are warnings here. You have to establish a vesting schedule — this means that you have to specify when you’re entitled to take those benefits from the Keogh after a certain length of time. You can’t just be automatically vested. If that’s going to be a problem, you might want to look into the SEP-IRA or the Solo 401(k) — the latter option being especially suitable for one-person companies.

Carefully studying your options with a Keogh plan is the real way to really make sure that you have retirement handled — what will you choose today?