What is Keogh Plan? – definition

Definition of Keogh Plan. The Keogh Plan was passed by Congress in 1962. It covered self-employed workers. In 1984, Congress put the Keogh Plan on equal footing with existing pension plans in the private sector. Workers who are covered by pension plans in the private sector, and who, in addition are self-employed can open Keogh accounts. Investment income does not qualify as work income.
The maximum annual contribution amounts to $30,000, but it can not exceed 25% of self-employed income. The Keogh Plan offers investors two tax advantages: 1) investors can deduct the contribution to Keogh accounts from their self-employed gross income, thus lowering taxes directly, and 2) taxes on investment income or capital gains accrued in the account can be deferred until retirement. The disadvantage of the Keogh account is its lack of liquidity. This means an early withdrawal is subject to penalties. The second disadvantage is that changes in the tax code may affect these accounts. Despite these disadvantages, self-employed workers take advantage of tax breaks afforded to them depositing monies in their Keogh accounts.

401(K) Plan in comparison with Keogh Plan
401 (K) Plans are named after Section 401 (K) of the Internal Revenue Service Code. This plan is generically known as a Salary Reduction Plan. It covers workers of companies who have adopted this plan. Since only a small percentage of firms have selected this plan, it is less popular than the IRA, despite the fact that it’s much better than the IRA. The 401 (K) plan became more popular in the late eighties once it was adopted by the biggest American firms.

Participants in a 401 (K) Plan typically reduce their salaries through automatic payroll withdrawal. This directly lowers their taxes. The taxes on investment income or capital gains are deferred until retirement. In 2005 Congress limited the maximum contribution to $7,000 annually which compares favorably to the maximum contribution of $2,000 in an IRA. The maximum contribution level will be adjusted in future years based on inflation. For example, in 1994 the maximum contribution was $9,240. Another advantage of a 401(K) is the potential for matching contributions by employers. Some employers contribute $50 for every dollar contributed by their employees.
Salary reduction plans differ amongst companies. For example, one company may offer a 401 (K) Plan restricting investments to shares of its stock, while another may offer this plan allowing employees to invest in a selected number of mutual funds. Yet another may allow their employees to invest as they wish. The features of lowering current taxes, and a potential contribution from an employer in conjunction with tax deferral, make the salary reduction plan extremely attractive, proving a reduction in income can be afforded.

Comparison of Retirement Accounts

Participants

All workers

Self employed

Employees of a firm which adopted this plan

Maximum contribution

$2.000 or $2.250 for families with only one spouse working

$30.000 or

25% Gross Income

$15.000

Contribution deduction

Depends on Gross Income

Entire Contribution

Entire Contribution

Deadline for opening the account

April 15 of next year

December 31 of the current year

December 31 of the current year

Deadline

for

Contribution

From January 1 of the current to April 15 of the next year

From January 1 of the current to the time of tax filing, including extensions

From January 1 to December 31 of the current

Investment Possibilities

Most of the financial instruments

Some of the financial instruments

In accordance with employers rules

 

Table above compares retirement plans on the basis of participation, maximum contribution, maximum deduction from current income, latest date for establishing an account, date of contribution, and investment possibilities.
The best retirement account for the self-employed is the Keogh Plan self-employed individuals can deduct up to $30,000 annually. Their contribution can be made until their submission of taxes, including extensions. Under this plan participants have the full freedom of choosing any investments.
The salary reduction plan allows participants to deduct up to $10,000 a year, but is limited to employees of companies who have adopted the 401 (K) plan. Investment freedom depends upon the employer. A 401 K plan which allows employees a variety of investment choice would be the most desirable for employees of a company.