With all the talk of 401ks and IRAs, many small business owners are left in the dark when it comes to setting up a retirement savings fund for themselves andor their employees. A Keogh plan, sometimes known as a HR10 plan, was designed with the small business owner in mind. First enacted in 1963, this tax deferred retirement savings fund is available for the owner or owners of an unincorporated business and its employees. Since the contributions are deducted from the gross income, one benefit of the plan is a reduction in pre-tax income. Other benefits of the Keogh plan include contributions that are tax deferred until withdrawn, deferred interest income, certain lump sum benefits which are eligible for 10-year averaging, and contribution limits higher than those of IRAs.
As with all retirement savings plans, the Keogh plan has early withdrawal penalties if the participant is more than 5% owner, and payments must begin by April 1 of the year the participant turns 70. Withdrawals from the plan cannot begin until the participant is 59 years of age and retired.
Within the Keogh plan, there are two types of saving plans: the defined benefit plan and the defined contribution plan. With the defined benefit plan, the participant defines how much he or she wishes to withdraw upon retirement. Using this number, an actuarial formula is employed to calculate the percentage contributed based on life expectancy of the participant, amount desired, and number of years left to contribute before retirement. With the defined contribution, the participant chooses how much he or she wishes to contribute on a yearly basis to the Keogh plan.
In a Keogh plan's defined contribution plan, there are two ways in which an employer may contribute to the plan: a profit sharing plan and a money purchase plan. With the profit sharing plan, the contribution is dependent upon the profits of the business. One advantage of this type of plan for owners is that the law allows for skipping contributions during lean years. In the money purchase plan, a set amount is contributed every year, with no allowances for profits or losses. With both types of defined contribution plans, the maximum deduction limit is 25%.
The Keogh plan requires that the contributions be made in cash, but they can be invested in a variety of ways. Vested assets are held in trust for employees and can be rolled over into an IRA if they leave the business. A large benefit for the owner of the business is that he or she can deduct the entire yearly Keogh contribution for himself as well as those made for his employees.