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Keogh Plan: Definition, Pros & Cons

Instructor: Yuanxin (Amy) Yang Alcocer

Amy has a master's degree in secondary education and has taught math at a public charter high school.

Read this lesson to learn how self-employed individuals can save for their retirement. Learn about the federal government's provision for opening up a retirement savings plan for those that work for corporations.

Keogh Plan

In this lesson, you will learn about the options self-employed individuals have when it comes to setting up a retirement savings plan. The federal government actually signed this provision into law way back in 1962. This provision was referred to as a Keogh plan named after Rep. Eugene James Keogh. Put simply, a Keogh plan is a retirement plan for self-employed individuals. It actually also benefits those who earn a lot. This term is an old term, and you can't set up a Keogh plan anymore. Today, self-employed individuals can open up SEP IRAs (Simplified Employee Pension Individual Retirement Accounts), 401(k) plans, or SIMPLE IRAs (Savings Incentive Match Plan for Employees Individual Retirement Accounts).

Types

All of these accounts and plans fall under two different categories: defined contribution plans and defined benefit plans. Let's take a closer look at these.

Defined Contribution Plans

The first type is referred to as defined contribution plans. These are plans where you are allowed to contribute funds up to a certain percentage of compensation. There are two sub-types within this group. With the profit-sharing plan, you choose the amount to contribute each year up to 25% of compensation. With the money purchase plan, you choose a certain percentage up to 25% of compensation to contribute, and you stick with it year after year.

Defined Benefit Plans

The second type is referred to as defined benefit plans. These are plans where you choose your desired annual benefit. Your yearly contributions are then calculated based on your desired benefit amount. This type has no contribution limit so individuals who earn a lot can benefit and save more from this type of account.

Pros

Now that you know what a Keogh plan is and the types that are available, let's talk about the pros and cons of opening up a retirement plan for self-employed individuals.

The first benefit is that you can contribute a higher amount than you could if you had a traditional IRA or 401(k). With the retirement plans for self-employed individuals, you can contribute up to 25% of compensation.

The second benefit is that all of your contributions are tax deductible.

The third benefit is that you can take your contributions and invest it in the same options that you could with a traditional IRA or 401(k). These options include mutual funds, stocks, bonds, annuities, and some other types of securities. These investments will help grow your savings even more.

Cons

As for the cons, the first con is that, well, you have to be self-employed. Even though you can contribute more, you also have to pay for everything related to the business. You have to pay for your own health insurance, and you have to pay for your own Social Security.

The second con is that if you withdraw your money early before you reach a certain age, you will pay a penalty for it.

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