Chapter 6 — Keogh Plans

Beginning in 1963, self-employed individuals were, for the first time, permitted to participate in qualified retirement plans. Plans for the self-employed are commonly called Keogh plans, named for U.S. Representative Eugene Keogh, who introduced the Self-Employed Individuals Tax Retirement Act of 1962.

At the outset, the tax benefits available under Keogh plans were quite modest compared to those available to corporate plans. Over time, Congress steadily increased the contribution and deduction limits:

• The Economic Recovery Tax Act of 1981 significantly increased Keogh contribution and deduction limits.
• The Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA) placed Keogh plans on substantially the same footing as corporate qualified plans, effective beginning in 1984.

Before TEFRA, many tax advisors recommended that sole proprietors and partnerships incorporate solely to take advantage of the more generous corporate qualified plan rules. After the 1982 changes, that strategy became largely obsolete — Keogh plans now offer essentially the same benefits as corporate plans.

Any taxpayer who owns all or part of an unincorporated business and performs personal services for that business may establish a Keogh plan. Two important conditions:

• The owner must actively work in the business — passive investors who earn only investment income from a business do not qualify.
• The business must be unincorporated — sole proprietors and partners in a partnership are the classic Keogh candidates. Owners of S corporations and C corporations have access to corporate qualified plans instead.

A self-employed individual who contributes to a Keogh plan may also establish an IRA and make contributions to it, though the IRA deductibility will depend on income and active participant status. Additionally, a SEP-IRA is another available option — it uses an IRA as the funding vehicle but permits substantially larger contributions than a regular IRA, while requiring significantly less administration than a Keogh plan.

TEFRA (effective 1984) repealed most of the special restrictive rules that had applied to Keogh plans, including those that:

• set lower contribution and benefit limits for self-employed individuals compared to corporate plans,
• prevented some Keogh plans from limiting coverage to a fair cross-section of employees, and
• restricted integration with Social Security (permitted disparity).

At the same time, TEFRA extended several Keogh-specific rules to all qualified plans, including:

• before-and-after-death distribution rules,
• top-heavy rules (now applicable to all qualified plans), and
• integration of defined contribution plans with Social Security.

Even after TEFRA, a limited number of special requirements, definitions, and provisions still apply exclusively to Keogh plans — primarily relating to how self-employed “compensation” is defined (net earnings from self-employment rather than W-2 wages). These distinctions are explored in the sections that follow.

As with other qualified plans, a Keogh plan must be “qualified” to enjoy its tax benefits. Keogh plans fall into the same two broad categories as corporate plans: