Definition
A Keogh plan is a tax-deferred retirement savings plan for small businesses and self-employed individuals.
Explanation
A Keogh plan can be thought of as a pension plan that offers small businesses and the self-employed more options than a Traditional IRA, but less administrative paperwork than 401(k) plans. There are two basic forms of Keogh plans, which are called qualified plans. The two plan types are:
Defined Contribution Plans: these plans have defined formulas to determine the amount contributed to the Keogh. For example, the defined contribution might be based on a percentage of the employee's compensation.
Defined Benefit Plan: this plan is similar to that of a traditional pension plan. It uses actuarial assumptions to calculate the funding needed to provide for a certain level of benefit to the employee in retirement. That benefit is typically defined by a formula that considers both the salary of the employee as well as their years of service.
Employee and employer contribution limits for Keoghs are much higher than IRAs, and generally align with those of 401(k) and 403(b) plans. Contributions are also not phased out above a certain income threshold as they are with IRAs.
Keogh plans allow the individual to make contributions directly from their gross income on a pre-tax basis. (Income taxes are deferred until the money is withdrawn from the account.) Capital gains and interest earned are also allowed to grow tax-free until withdrawn.
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