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  Keogh Vs SEP Plans

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  Spring, 2004


Many of our clients who leave their previous employment to start their own business often find that a $3,000 IRA account just isn't likely to meet their retirement needs down the road.  There are other options available for self-employed individuals and this article examines a couple of them.


Retirement plans available to a self-employed individual vary from the very fundamental to the complex variety, which require the services of professional pension plan administrators.  

Among the plans available are the Keogh, SEP, and Defined Benefit and Simple IRA plans.   Because of their complexity and normally high administration costs, the Defined Benefit and Simple IRA plans are not discussed in this article.  However, older individuals should take note of the larger retirement contributions available with Defined Benefit plans which could justify the higher administration costs.  

Keogh Plans: A Keogh plan can be a Money Purchase or Profit Sharing plan or a combination of the two as explained later.  The overall annual contribution limit to a Keogh plan is 25% of the net profits less the retirement contribution made by the plan itself.  After doing the appropriate math, we find 25% of the net profits less the retirement contribution actually equates to 20% of the net profit.  The total contribution for the year is also limited to $40,000 and the maximum compensation upon which the contribution is based is limited to $200,000 (’03 rate, this contribution limit may be adjusted for inflation annually.)  

  Profit Sharing  Money Purchase
Contribution %  
20% (1)  25% (1)
Discretionary Mandatory
  (1) Based on net profit after deducting plan contribution.

As illustrated above the Profit Sharing plan has the lower limit on contributions, but the contribution is discretionary.  On the other hand, a Money Purchase plan provides a higher limit but contributions to the plan are mandatory each year.  The percentage limits for either the Profit Sharing plan or the Money Purchase plan can be set at a lower limit when the plan is established.  When an employer wishes to limit the mandatory contribution limit of a Money Purchase plan and at the same time maximize the annual contribution limit, combination plans can be established. 

Keogh plans must be established before the end of the year for which a contribution is made.  However, the contribution for any year can be delayed until later, but not later than the due date of the taxpayer’s individual return including extension. Reporting requirements for one participant with Keogh plans require that form(s) 5500-EZ be filed for the year the plan assets reach $100,000 and every year thereafter so long as the plan is in existence.  All other plans must file form(s) 5500 annually.  For calendar year taxpayers, the due date for this report is July 31.

SEP Plans: Unlike the Keogh plans, a SEP plan can be established after the end of the close of the tax year.  However, it must be established and funded by the due date of the taxpayer’s return plus extensions.  SEP plans are also referred to as SEP IRAs since they utilize IRA accounts as the depository for the plan contribution.  Even though the funds are being deposited into an IRA account, the SEP contribution is based on 20% of the net profits from the self- employed business.  An additional advantage of a SEP plan is there is no annual reporting requirements like those that apply to the Keogh plans.

Employees: If a self-employed individual has employees it may be necessary to include the employees in the plan.  Most plans require coverage once an employee attains age 21. With a Keogh plan, you don't have to cover employees until they have completed at least one year of service (two years in some cases). A SEP is a little different since you only need to cover employees who have worked for you during three of the past five years. Once this test is met, most part time workers will have to be covered under a SEP.


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