Keogh plans can be established in addition to IRA accounts, but since a Keogh plan is a qualified plan, your contributions to your IRA account may not be fully deductible. Additionally, if you work as an employee and participate in the employer's qualified plan, you can still have a Keogh plan if you have net earnings from self-employment. Your contributions are subject to the overall limitations for defined contribution plans and defined benefit plans.
IMPORTANT NOTE: Keogh plans must be set up by the end of the year to claim a tax deduction for contributions for that year. But you have until the due date of your tax return (including extensions) to actually make your contribution.
IMPORTANT NOTE: If an individual has self-employment income (typically consulting, director's fees, etc.) and is a non-owner employee (or has very little ownership) of another company, he or she could have a separate retirement plan for their self-employment income (but could not double up on 401(k) contributions).
How Keogh Plans Work
If you are self-employed, you can establish a Keogh (a qualified retirement plan) with contributions based on net earnings from self-employment. Contributions to Keogh plans are tax-deductible. The amount of the contribution depends on the type of plan you set up—either "defined contribution" or "defined benefit." No matter what type of plan you select, you must fund the Keogh of your eligible employees; i.e., you must make contributions to the Keogh plan for your eligible employees. For the employee eligibility rules, see the section Establishing a Keogh Plan. An overview of Keogh plan rules follows.
Defined Contribution Plans
Defined contribution plans are the most common type of Keogh plan, and include money-purchase pension plans and profit-sharing plans. There are overall contribution and deduction limitations to a Keogh plan.
For both types of plans, contributions in 2020 are generally limited to the lesser of $57,000 ($56,000 in 2019) or 25% of your self-employment income, after the retirement contribution is subtracted.
As the self-employed owner, you may be able to deduct up to 25% of the combined compensation of all eligible employees.
The contribution and the deduction for the contribution to your own Keogh are computed after you subtract your retirement plan contribution from your net earnings. This means that you can't actually put 25% of your self-employment income into your retirement plan. Effectively, you can put only 20% of your self-employment income into your plan. For example, if your self-employed income is $30,000 (net of ½ of the self-employment tax), you can contribute $6,000 ($30,000−$6,000 = $24,000 x 25% = $6,000; or $30,000 x 20% = $6,000) to your retirement plan.
Defined Benefit Plans
A defined benefit plan provides individuals with specified benefits at retirement, typically in the form of a monthly retirement benefit and typically based on levels of compensation and years of service. If you set up a defined benefit plan, you will need an actuary to calculate the amount necessary to fund the plan.
General Types of Keogh Plans1
|
Type |
Maximum Contribution2 |
Factors to Consider |
|
Money-Purchase |
$57,000 in 2020 ($56,000 in 2019) or 25% of the earned income2 from the business, whichever is less |
Contributions are required. You are locked into a specified percentage each year. |
|
Profit-Sharing |
$57,000 in 2020 ($56,000in 2019) or 25% of the earned income3 from the business, whichever is less |
Your contributions are flexible, up to the maximum percentage you initially set. |
|
Defined Benefit |
The plan funds for a fixed annual income at retirement.4 |
Allows older workers to put away substantially more money, but younger workers may not be able to put away as much as in a money purchase or profit-sharing plan. Also, there are higher administrative costs with a defined benefit plan. (Rewards older, longer-service employees over younger, short-term employees.) |
|
1 Assumes you are an owner-employee. 2 The employer must make a contribution to each eligible employee's account. This contribution is not currently taxable to the employee, but is taxed upon withdrawal. 3 Your earned income equals your income minus the retirement contribution and minus ½ of the self-employment tax. 4 The maximum defined-benefit you can fund is set annually by the IRS. |
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SUGGESTION: Your Keogh contributions are deductible on your individual income tax return. Deduct the contributions for your employees on Schedule C (or Schedule F if applicable) on your Form 1040. Take the deduction for contributions for yourself on page 1 of Form 1040 under the section Adjusted Gross Income.
