SEP Plan vs. Keogh Plan: Understanding the Key Differences for Small Business Retirement Savings

Thomas J Catalano is a Certified Financial Planner and Registered Investment Adviser based in South Carolina. Since founding his financial advisory firm in 2018, Thomas has developed expertise in investments, retirement strategies, insurance, and comprehensive financial planning.

SEP Plan vs. Keogh Plan: A Modern Comparison

For self-employed individuals and small business owners aiming to save beyond the traditional IRA limits, both the Simplified Employee Pension (SEP) plan and the Keogh plan offer powerful retirement saving options. These plans cater to business owners and their employees with several shared features:

• Participation is available to both employees and the business owner.
• Contributions are tax-deductible, reducing taxable income annually.
• Withdrawals during retirement are taxed as ordinary income.
• Accounts can be opened through banks, brokerage firms, insurance providers, or mutual fund companies.
• Funds can be invested across a broad spectrum of assets, including stocks, bonds, mutual funds, and ETFs.

Both plans allow significantly higher contribution limits compared to many other retirement options. For 2023, the maximum contribution is the lesser of 25% of net earnings or $66,000.

Key Insights

• SEP and Keogh plans are tailored retirement solutions for small business owners and their staff.
• The SEP plan operates exclusively as a defined-contribution plan, automatically allocating a percentage of income into a tax-deferred account.
• Employers are not obligated to contribute to employee SEP accounts, but if they do, contributions must be equitable for all qualifying full-time employees.
• Keogh plans are qualified plans under ERISA, offering structured retirement benefits.

Understanding the SEP Plan

The SEP plan is straightforward, designed as a defined-contribution retirement vehicle where participants allocate a portion of their gross income into tax-advantaged accounts.

Setting up a SEP is accessible, requiring submission of IRS Form 5305-SEP without necessarily needing professional help.

Simplified Compliance

SEP plans have no annual filing requirements, easing administrative burdens.

Employers may choose whether to contribute each year. If contributions are made, they must be consistent across all eligible employees aged 21 or older with at least three years of service within the last five.

Similar to IRAs, SEP contributions can be made up to the tax filing deadline, including extensions. However, borrowing against SEP funds is not permitted.

Exploring the Keogh Plan

Keogh plans are favored by high-income self-employed professionals, such as physicians and unincorporated business owners, offering more complex but flexible retirement options.

As ERISA-qualified plans, Keoghs require comprehensive documentation and adherence to federal standards, often necessitating assistance from financial or tax professionals.

Plan Documentation and Structure

Establishing a Keogh plan involves submitting detailed plan documents to regulatory authorities.

Keogh plans can be structured as defined-contribution or defined-benefit plans, providing flexibility in retirement funding strategies.

Contribution Limits and Benefits

Defined-contribution Keogh plans share contribution limits with SEPs – up to 25% of net earnings or $66,000 for 2023.

Defined-benefit Keogh plans offer higher limits, with benefits up to $265,000 for 2023, resembling traditional pension payouts.

Defined-contribution plans may be designed as money purchase or profit-sharing plans. Profit-sharing allows variable contributions based on yearly profits, while money purchase plans require fixed annual contributions.

Keogh plans include annual reporting requirements (Form 5500) and permit loans within set guidelines.

Choosing the Right Plan for Your Business

Small business owners seeking a simple, flexible retirement plan for themselves and employees often favor SEP plans due to ease of administration and equitable contribution rules.

For higher earners with stable income, defined-benefit Keogh plans provide a powerful pension-like vehicle with substantial tax advantages.

If neither plan aligns perfectly with your goals, consider alternative options such as solo 401(k)s, traditional or Roth 401(k)s, or defined-benefit plans like the 412(e)(3).

Who Qualifies for a SEP Plan?

Eligibility for SEP includes employees aged 21 or older who have worked at least three of the last five years and earned a minimum compensation ($650 in 2021 and 2022).

Who Can Open a SEP IRA?

SEP IRAs are available to business owners with employees as well as self-employed individuals. Contributions are made directly into traditional IRAs established for each employee.

Is a Keogh Plan the Same as a 401(k)?

While both Keogh and 401(k) plans are tax-deferred retirement options, Keogh plans generally have higher contribution limits and are designed for self-employed individuals and unincorporated businesses, differing from the typical 401(k) structure.

Correction—Dec. 2, 2021: This article replaces references to 412(i) plans with 412(e)(3) plans, reflecting regulatory updates since 2007.

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